Employee Benefits

Avoid Potential Tax Problems with the Internal Revenue Service

Do you have a formal plan for continuing pay for an owner or other key employees?

If one of the owners or other key employee was disabled yesterday, would your company continue to pay a portion of their income for a period of time?

When a key person becomes totally disabled, it is too late to adopt a formal sick-pay plan. Federal laws and IRS regulations state that a sick-pay plan must be adopted before the disability begins. The government has ruled that, unless the business has a bona fide sick-pay plan, the income paid to the business owner or key person will be considered as ad hoc payments. This is because the disabled person who is not covered by a plan before disability begins is considered an ex-employee. Money paid to ex-employees is not considered wages.

If ad hoc payments are made, they are not:
  • Necessary business expenses,
  • Tax-deductible, or
  • Eligible for the sick-pay tax credit.

In addition, if these payments were made to a stockholder-employee the likelihood that would be that such payments are dividends and taxable as such. The consequences - potentially devastating to your bottom line.

Take a look at the chart below. We are assuming a final $50,000 profit and 34% corporate tax rate.

Ad Hoc Plan Formal Self-Insured Plan
Profit $50,000 Profit $50,000
Tax $17,000 Sick Pay $30,000
Net Profit $33,000 Net Profit $20,000
Sick Pay $30,000 Tax $6,800
Tax on Dividend $1,200 Net $13,000
Net ($7,200)

The Solution
I would like to recommend that you look into a formal sick-pay plan for you and possibly some key people at your business. There is virtually very little or no cost in adopting such a plan. The process will also give the you a clearer picture relative to your own family's financial security should a serious illness or accident render you unable to earn an income for any specific period of time.

The Qualified Sick-Pay Plan (QSPP) is a formal program for continuing one's wages (including stockholder-employees) in the event of a disability. While QSPP's do not have to be, may business owners elect to fund the disability payments through disability insurance, thus transferring the potential unknown "cost" of a long term convalescence to a manageable and predictable " known" in the form of an insurance premium. I suggest that you refer to Section 105 and 162 of the Internal Revenue Code or your tax advisor, as premiums for the QSPP's insurance may be tax-deductible as a necessary business expense.






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