Overview of Taxation of Employee Sponsored Benefits This page is not tax advice, it is an overview of how premiums and benefits can be treated for income taxes. You should consult qualified tax advice to apply this information. Use the menu to quickly go to your area of interest. Medical Premiums Because there are different forms of a business, the taxation is different for employees and owners. Basically, a business can deduct the premiums paid for employee medical insurance without the premiums being income to the employee. However, in a non-C corporation, such as a Sub-S, partnership and sole proprietorship, the premiums paid for owners/stockholder are income to the owners. The taxation of those premiums is the same as allowed for any person paying their own medical premiums. The IRS/DOL rules say that individual employees can not be discriminated against in offering medical insurance and paying their premiums. An employer can discriminate by class in both of these areas. Smaller employers do not have the luxury of offering multiple levels of coverage to different classes of employees, but larger ones can. However, all employers can discriminate by class on the employer portion of the premium. An employer can institute a formal plan, however most employers I work with want to discriminate by employee not necessarily a whole class. The easiest way to do that is adopt a premium only plan (POP, see cafeteria plans for more information.) then bonus additional income to those employees to pay a larger portion of their premiums. The additional bonus is income, but the POP allows employee premiums to be paid pre-tax, so it washes the tax. Read about Health Savings Accounts (HSA) and purchasing a large deductible medical plan with a pre-tax account to fund the deductible with, click here. back to the menu Group Life Insurance An employer can purchase up to $50,000 of group life insurance for each employee without income incurring to the employee. Again, owner's premiums are not income tax deductible such as in a Sub-S corporation or partnership. Any life insurance over $50,000 does create a taxable event. The tax table to use is called Table 1. The taxable income must be included on the employee's W2. Often it is cheaper to purchase individual term life than use the Table 1 costs. A common approach to this situation is for the employer to provide one times income in life insurance to $50,000 and let the employee purchase additional life on a payroll deduction basis themselves, since it is after tax anyway. If the employer chooses to offer more than $50,000 of group term, the Table 1 cost (so much per thousand) must be added to the employee's W2. back to the menu Group Long Term and Short Term Disability Income If the employer pays 100% of the disability premiums, it is fully deductible with no income to the employees. Again, an owner's premiums are not deductible unless the employer is a C corporation. However, since the employer is deducting the premiums, at the time of claim, the benefits are income to the employee. It it possible for the group disability to be contributory, meaning the employees can pay part or all of the premium themselves. However, different disability vendors have rules regarding a minimum size to allow the premiums to be contributory. For example, UNUM requires  employers from 2-9 employees to pay 100% of premiums. Over 10 employees, there is more flexibility for product and premiums. A fully contributory plan, meaning fully paid by the employees, rarely works since the insurance companies require a minimum participation. A solution for getting a plan accepted is for the employer to offer at least a base plan, say cover 50-60% of income to $3,000 a month of benefit. If the employees desire a higher level of coverage, they can add to it on a payroll deduction plan. I use this option frequently to reduce the employer out of pocket costs. back to the menu Voluntary Benefits Employees like to be able to add to their own personal insurance on a payroll deduction basis. An employer can offer: life insurance for the employee and family, disability, long term care, accident benefits to name the primary products. The voluntary benefits are all on a after tax basis.  However, the employee can elect to put certain "health" insurance plans into the Premiums Only Plan (POP) of an employer sponsored 125/cafeteria plan. If the employee chooses to have his disability income premiums be pre-tax, at the time of claim the benefits would be subject to income tax. What is better, deduct ongoing premiums and pay taxes on the benefits. Or pay taxes on the smaller premium and get the benefits tax free. Most employees I work with do not elect to pre-tax disability premiums.  Long term care insurance is an exception. Current tax law allows a portion if not all of qualifying long term care premiums to be tax deductible. back to the menu Retirement Retirement plans such as profit sharing, 401k plans and Simplified Employee Pension are all tax deductible to the employer with no income currently to the employee. The benefits coming out are all subject to income tax. Withdrawals or distributions prior to age 59 1/2 may also be subject to a 10% "early withdrawal" penalty to the employee. back to the menu Key Person Benefits An employer can reward a specific employee by paying part or all of the premiums on personal insurance. An employer may offer to pay, for example, 50% of the premiums on additional disability for an employee. The employer paid portion of that premium would be income to the employee. How the employee treats the remaining premium would be the same as any voluntary disability plan. If the premiums are pre-tax, the disability income benefits are taxable income. back to the menu