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Individual - Federal and State level - Taxability of state disability insurance proceeds

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We have researched both the federal and state tax ramifications of the state disability insurance proceeds received during fiscal year 2004. Our understanding of the facts the way you described them to us during our April 05, 2005 conference call are as follows: 1) During 2005 you have been the beneficiary of state disability payments. 2) Your employer has withheld out of your net pay the cost of state disability insurance premiums. 3) The premiums withheld of your net pay have been deposited state agency by your employer.
 

FEDERAL LEVEL The definition of gross income in accordance with the current tax code is: all income from whatever source derived”. The issue at hand is to identify a specific code section that allows you to exclude the payments of state disability insurance received from the state agency. The disability insurance proceeds received “through accident or health insurance for personal injuries or sickness (or through an arrangement having the effect of accident or health insurance)” is specifically excluded from gross income by code section 104(a)(3). The exclusion is valid only if certain requirements are met. The first requirement is that the benefits are not being paid by your employer while the second requirement is concerned with insurance premiums paid on your behalf by your employer that have not been included in your gross income. Furthermore Treasury Regulations Regulations 1.104-1(d) shed more light on insurance proceeds received by you and paid with your own funds.
 

STATE LEVEL California conforms to IRC104 concerning compensation for injuries or sickness (California Revenue and Taxation Code 17131). Amounts received through accident or health insurance for personal injuries or sickness attributable to the taxpayer's own contributions are excluded from gross income of the taxpayer. Since the proceeds have been disbursed by a state agency and your employer has not cover the cost of your insurance premiums but the funds have been withheld from your wages it is our conclusion based upon the state facts and the relevant authority cited that the proceeds received by you during the fiscal year 2004 are tax exempt.
If you would like to discuss any of these matters in more detail, please e-mail us.

 

Very truly yours, TaxCaffe

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