The Ice Cream Tax
by Steven L. Brady RHU, 2nd Vice President IDI Sales & Marketing
There is a really outstanding opportunity for disability insurance sales professionals. It is a market represented by 99.7 percent of all employer firms in the United States1. Before I tell you what the market is, and how you can bring important information to them, permit me to tell you a story of a business owner who suffered a disability, using a fictitious Ice Cream Tax, a real ice cream company and a very real IRS.
There once was an ice cream company. Its owner was the driving force behind the company until he was disabled. The ice cream company took good care of its employees and had an informal policy of paying employees while they recovered from illnesses and injuries. In keeping with that policy, the ice cream company's management continued to pay the business owner his predisability compensation. They also continued to deduct those payments as business expenses on the company's tax returns, reporting the payments as salary.
The IRS determined that the ice cream company's deductions were improper, imposing what I refer to in this article as an "Ice Cream Tax." The IRS ruled that the salary paid to the business owner was not deductible as a salary expense to the company since there was no written salary continuation plan in place before the disability occurred2. As a result of the IRS's decision, both the owner's estate and the company had to pay back taxes, penalties and interest.
The lesson for business owners is that their companies cannot deduct disabled employees' or (business owners') salaries as a business expense unless they have a written salary continuation plan in place before the disability occurs.
Without a salary continuation plan in place prior to disability, the IRS considers salary payments to disabled employees or owners to be gifts or dividends, rather than compensation for services performed. These payments are taxable to the recipient, and non-deductible for the business. As with the ice cream company owner above, a business's generosity can result in an effect opposite to that intended.
The Sales Opportunity For You
I began this article with a reference to opportunities in a huge market in the United States. The market is small business owners. They work hard to build their companies and try to help out their employees, until a situation like the Ice Cream Tax comes along. This sort of problem often can be avoided with a bit of useful information. You can be the trusted advisor who brings this information to the attention of small business owners. You can also provide the solution.
What Qualifies As A Salary Continuation Plan
In order to qualify payments under a salary continuation plan, a business must:
- Establish a salary continuation plan, in writing, before any disabling event occurs,
- Have the business formally adopt the plan, using normally accepted business documentation, such as a corporate resolution for a corporation, and
- Communicate a description of the plan in writing to covered employees.
Funding a salary continuation plan with insurance is a great way for business owners to control the financial risks associated with disability. There are level premiums, disability definitions that make the premiums budgetable and allow the definitions of the policy to police the disability so the business owner or management team does not have to make the tough decisions that can be fraught with emotion.
One More Value You Bring To Your Customers
Benefits payable due to a disabling event should not be taxed as business profit. Keep the normal business expenses deductible for owners or employees, disabled or not. Reach out to your existing business owner contacts, as well as to new ones. Those who know you will welcome your concerned advice. Those who do not know you will come to trust your advice.
1. Frequently Asked Questions, Small Business Administration, Office of Advocacy. September 2009.
2. Chism v.CIR. T.C. Memo. 1962-6, aff'd 322 F.2d 956 (9th Cir. 1963)