An employer pays the entire premium for a group long-term disability policy covering its employees. If an employee receives disability benefits under this policy, those benefits are:

Why A is correct

The tax treatment of disability benefits follows the source of the premium dollars. When the employer pays the full premium for a group disability policy, the employer's payments are not included in the employee's income at the time of payment, but any benefits the employee later receives are taxable as ordinary income. If the employee had paid the premiums with after-tax dollars, the benefits would be tax-free; if the premiums were split, the benefit is taxable in proportion to the employer's share. This premium-source rule is the controlling principle for disability benefit taxation.

Why the other options are wrong

• B) Disability benefits are not always tax-free. Taxability follows the source of the premium dollars: employer-paid plans produce taxable benefits, while personally paid after-tax premiums produce tax-free benefits to the insured.
• C) Replacing lost wages does not by itself make benefits tax-free. The controlling factor is the tax treatment of the premiums, not the fact that the benefit substitutes for lost income.
• D) There is no one-year or other duration rule for taxing disability benefits. The source of the premium dollars determines taxability from the first benefit payment, regardless of how long the disability lasts.

Memory hook

Employer pays the premium, so the benefits show up as taxable income.