Tax Treatment of Premiums and Proceeds of Health Insurance Contracts

Explain the tax treatment of premiums and proceeds of health insurance contracts.

Disability Income Payments

Disability income insurance can be provided as a rider to a life insurance policy or through a separate contract. In either event, income payments on policies owned and paid for by the insured are received by the insured tax free. Where payments are made to a policyowner other than the insured — for example, to a corporation which has purchased the disability income insurance as key employee insurance — the benefits paid by the insurance company continue to be tax free.

A different situation arises, however, where disability income insurance is paid for by an employer to fund a salary continuation plan for employees and the benefits are paid by the insurance company directly to the individual employees. Upon receipt of disability income from such a policy, an employee must include as income amounts received during the first 30 days of continuous disability and amounts in excess of $100 per week thereafter. However, where the sick pay provided is less than 75 percent of the employee’s weekly rates of wages, this fully taxable period of 30 days is reduced to 7 days or eliminated entirely if the employee is hospitalized. In this situation, the tax-exempt amount payable to such an employee during the first 30 days is limited to $75.

Medical Reimbursement

Benefits payable from hospital and surgical policies, major medical policies and other medical expense coverages, whether individual or group, are exempt from income tax. However, any benefits received must be used to reduce the amount of related medical expenses otherwise deductible for the year. In addition, to the extent that reimbursement is received for medical expenses taken as a tax deduction in a prior year, it will be taxable in the current year.