381 / How are benefits provided under an employer-provided disability income plan taxed?
A disabled former employee could not exclude from income a lump sum payment received from the insurance company that provided the employee’s employer-paid long-term disability coverage. The lump sum nature of the settlement did not change the nature of the payment into something other than a payment received under accident or health insurance.3
If benefits are received under a plan to which an employee has contributed, the portion of the disability income attributable to the employee’s contributions is tax-free.4 Under an individual policy, an employee’s contributions for the current policy year are taken into consideration. With a group policy, an employee’s contributions for the last three years, if known, are considered.5
In Revenue Ruling 2004-55, the IRS held that the three-year look back rule did not apply because the plan was amended so that, with respect to each employee, the amended plan was financed either solely by the employer or solely by the employee. The three-year look back rule does not apply if a plan is not considered a contributory plan.