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How to Insure Your Income: Chapter 4 - Tax Issues

Premiums paid for individually owned disability income insurance are not tax-deductible, since they are not considered premiums for medical care insurance. However, the benefits paid by a disability policy are tax-free.

An employer can deduct premiums paid for group disability insurance on employees as a business expense, provided the employer is not the beneficiary of the policy (benefits are payable to the employees, not the employer). The value of the coverage provided by the employer is not considered taxable income to the employee. However, benefits are taxable.

Payments for permanent losses under accidental death and dismemberment coverage (such as loss of a limb or bodily function, loss of sight or hearing, or permanent disfigurement) are not included as taxable income to the employee, regardless of who paid the premium.

Accidental death benefits available under a disability policy are considered life insurance benefits and are received income tax-free by the beneficiary, provided the contract meets the IRS statutory definition of life insurance (this means the policy's cash surrender value cannot exceed the net single premium necessary to fund future benefits, and the policy must meet other minimum requirements).

Basically, the concept is that if one party receives a tax deduction for the premium, the other party will be taxed. Either the premium or the benefit will be taxed. If the benefit is received tax-free, the premium was taxed.

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