If the employer provides group term disability insurance as a nontaxable fringe benefit to the employee, then benefits received under the plan are taxable to the employee. However, per IRS Revenue Ruling 2004-55, the employer can have the plan allow for the employee to elect each year whether or not they want the premiums to be included in their taxable wages. If the plan does not allow for such an election, the employer can amend the plan to add this feature.
If the premiums are taxed to the employee, then the benefits are not taxable. However, in Revenue Bulletin 2004-26, the IRS indicates that there is a three-year lookback period on disability benefits to determine how much should be taxed. If a portion of the premiums for the prior three years were not taxed to the employee, then the taxable portion of the benefits will be based on the ratio of untaxed premiums as compared to the total premiums.
If you have questions about taxation of disability benefits and premiums paid, please contact your ShindelRock tax professional.