Regarding a disability policy funded by an employer, which statement best describes the tax treatment of benefits paid to the employee?

• A. Benefits are tax-free to the employee.
• B. Benefits are partially taxable.
• C. Benefits are taxed to the employee only if premiums were pre-tax.
• D. Benefits are fully taxable.

Answer: (D)

When an employer funds a disability policy, the premiums are treated as a business benefit paid by the employer, not as after‑tax wages paid by the employee. Because the employee didn’t contribute after‑tax dollars toward the premium, the benefits received are considered taxable income to the employee. In this common arrangement, the entire disability benefit is taxed as ordinary income. If the employee had paid the premiums with after‑tax dollars, the benefits would typically be tax‑free. The notion of partial taxation doesn’t apply here, and the employer‑funded setup is the reason the benefits are fully taxable.