Salary Continuation Plans

Problem: Employers face three problems when their employees are disabled:

1. First, the loss of service can take its toll on the business.
2. Second, paying salaries or wages from company profits to a disabled employee can result in a severe drain on cash flow.
3. Third, if a replacement worker is hired and the disabled employee is still on the payroll, the employer, in effect, is paying two people to do one job.

Solution: The ideal solution is a salary continuation plan, a tax-favored way for businesses to pay for individual disability income insurance for the principals and selected employees. These formal arrangements are the only way to continue a portion of current salary to a disabled employee without triggering substantial tax penalties.

The employer's future plan obligation should be funded with individual disability income insurance, which is owned by the covered employee but with premiums paid by the employer. Premiums for employee coverage are deductible to the corporation, and do not create taxable income for the employee. Benefits received are taxable income to the employee.

However, premiums paid for sole proprietors, partners and most S corporation shareholders are not deductible. In these situations, benefits are received income tax-free.

Reference: ON-Trac Disability Income for Businessowners & Professionals Module (Form 1178.21)

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