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Is it possible to provide tax-free disability benefits?
Yes, but only if your covered employees pay for cost of disability coverage on an after-tax basis. Disability contracts usually require 100% participation to avoid adverse selection. Therefore, the most effective method is to continue to pay for coverage, but gross up salaries by the cost of coverage, and then deduct it from pay. Or, add the cost of coverage as imputed income to each covered employee's taxable wages. The IRS issued a revenue ruling that employees can make an irrevocable election once a year to be taxed or not on disability premiums. If you want to offer this option to employees, it is important to notify your disability carrier and verify the contract and rates reflect this change.