Why Income Continuation Pay Is Taxed as Wages
Employer-funded income continuation, paid while an employee is out, is generally treated as wages. Payroll tax and withholding apply, and it should be reported that way.
What to know.
That is different from insurance benefits paid for by an employee with after-tax dollars, which can be tax-free to the employee. How the plan is funded decides which applies.
Coordinate with payroll so withholding is right, and tell employees in writing how the pay is treated.
Where to look next.
Income Continuation Overview
How these accounts work.
Disability Plan Coordination
How employer pay and insurance fit together.
Compensation Strategy
How benefits fit total pay.
How Income Continuation Is Treated.
Income continuation pays part of an employee’s wages while they are out. When the employer pays for the coverage, benefits are generally treated as wages, so payroll tax and withholding apply. When the employee pays the premium with after-tax dollars, benefits are generally not taxable.
The details depend on who pays, how it is paid and whether premiums are pre-tax. Payroll and the carrier should know which applies.
Employers who get this wrong tend to find it at tax time, so decide it at plan setup.
Common questions on this topic.
Four questions to settle before you rely on it.
Is the pay subject to payroll tax?
Employer-funded pay is generally wages. Ask your CPA about your plan.
What if the employee pays the premium with after-tax dollars?
Benefits attributable to after-tax premiums are generally not taxable, but confirm with your adviser.
Who withholds?
Whoever pays the benefit, the employer or the carrier, depending on the setup. Confirm it at plan setup.
Should we tell employees?
Yes. Explain how the pay is treated so they can plan.
Does the carrier report the pay?
It depends on the arrangement. Confirm with the carrier and payroll who reports.
What if the premium is shared?
The taxable portion may follow the employer’s share. Ask your adviser.
Does this affect the W-2?
It can. Make sure payroll knows how to report.
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General information, not legal or tax advice. Plan-specific questions belong with your counsel or CPA, and we will bring them in.
Related guides.
Income Continuation Accounts
The overview this page belongs to.
Compliance Services
How CFH supports the compliance side of your plans.
The Elimination Period in Income Continuation
A related question on the same program.
Where the Rules Come From.
The laws and rules named on this page link to the statute or regulation they come from. This is general information, not legal or tax advice, and rules change, so check the current text.
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