Arizona Life and Health Practice Exam

What is the tax implication for benefits received by a company from an individual disability income insurance policy on a key employee?

1. Benefits are taxable as income

2. Benefits received are tax-free by the company

3. Benefits need to be reported as capital gains

4. Benefits are subject to self-employment tax

The correct answer is: Benefits received are tax-free by the company

The benefits received by a company from an individual disability income insurance policy on a key employee are tax-free for the company because the policy premiums are paid with after-tax dollars. The Internal Revenue Service does not tax benefits received from a disability income insurance policy when the premiums were not deducted as business expenses. In this scenario, because the company cannot deduct the premiums paid on the policy, the benefits received business are treated as tax-free income. This treatment encourages businesses to secure key employee coverage without the added tax burden on the benefits when claims are paid out. Other options do not reflect the typical tax treatment for such benefits, which is why they are not applicable in this context.