Employer-Paid vs. Employee-Paid Long-Term Disability Premiums: How Who Pays Affects Whether Your Benefits Are Taxable

The three Long-Term Disability premium arrangements you need to understand 

Note: CRA describes a wage-loss replacement plan as a group arrangement funded in whole or in part by the employer that provides periodic compensation for lost employment income due to sickness, accident, or maternity. LTD can fall within this category.

It’s not enough to say, “I paid some of the premiums.” You need to know the answers to three questions:

1. Did the employer contribute anything to the plan?
2. How much did you personally contribute?
3. Have your contributions already been used to reduce taxable LTD benefits in a previous year?

Why does who pays the Long-Term Disability premium matter?

 Notes: Paragraph 6(1)(f) of the federal Income Tax Act deals with periodic payments replacing lost employment income under:

• sickness or accident insurance plans
• disability insurance plans
• income-maintenance insurance plans

 Important clarification:

• Federal tax rules determine whether LTD benefits are included in income for Ontario residents.

Scenario 1: Your employer paid all the LTD premiums

General concept: If your employer funded the group wage-loss replacement plan, periodic benefits replacing your employment income are generally taxable.

• While you’re working – The employer pays premiums; the employee usually does not include that contribution as an employment benefit relating to periodic WLRP benefits.
  
  
• During disability – LTD income is generally taxable. (The legislation specifically distinguishes employer contributions attributable to benefits that will later be taxable under paragraph 6(1)(f).)

Example: Tax withholding may reduce the actual deposit. Suppose the policy pays $4,000 a month. If the LTD benefit is taxable, the claimant will not have the full $4,000 to spend.

Why it matters:

The “net” amount actually received matters for:

• mortgage planning
• rent
• medications
• debt payments
• family expenses
• settlement decisions

Scenario 2: You paid the entire LTD premium yourself

 What is an “Employee-pay-all plan?

CRA refers to an employee-pay-all plan where employees are obligated to pay the entire cost of the disability plan. This is distinct from a plan funded entirely by employee contributions from an employer-funded replacement plan.

• Where the plan is genuinely employee-pay-all, benefits are generally outside paragraph 6(1)(f)’s employee-contributed disability benefit rule.
  
  
• CRA’s long-standing administrative interpretation states that benefits from an employee-pay-all plan are not taxabe under paragraph 6(1)(f).

Note: A payroll deduction establishes that the employee paid something; it does not necessarily prove the employee funded the entire plan.

Scenario 3: You and your employer both paid the premiums

1. If the employer contributed to the plan, paragraph 6(1)(f) may apply.
   

However, the statute allows the taxable benefits to be reduced by qualifying contributions made by the employee that have not already been used to reduce benefits in an earlier year.

2. Misconception to avoid:

The legislation does not simply divide each benefit according to the employer/employee premium percentage. What is true is employee contributions may be used to reduce the amount included in income.

3. CRA’s current individual tax guidance:

Recipients should report WLRP benefits minus eligible contributions they made to the plan that were not used on a previous return.

Illustrative example: A claimant receives $30,000 of taxable-plan LTD benefits and has $3,000 of eligible employee contributions that have never previously been used to reduce taxable LTD benefits. The contributions may reduce the amount required to be reported, rather than making a fixed percentage of every cheque tax-free.

* Note: Actual calculations depend on the claimant’s contribution history and tax records. It is best to have a tax professional confirm the amount.      

Answers to ten frequently asked questions:

1. Does an “after-tax payroll deduction” matter?

1. The pay stub is evidence.

     A deduction appearing on a pay stub can help establish employee contributions.

2. The plan’s funding arrangement is the answer.

    Payroll “mechanics” matter. Was the employee responsible for the entire disability plan cost, or did the employer also contribute?

2. How do you find out who actually paid your LTD premiums?

Step 1: Check your pay stubs.

Look for wording such as:

• LTD
• LTD premium
• disability
• group disability
• DI

Step 2: Review your benefits booklet.

Look for:

• premium information
• cost-sharing
• employee contributions
• employer contributions
• “100% employee paid”
• “employee-pay-all”

Step 3: Check your benefits enrollment documents.

This is especially useful if employees choose coverage annually

Step 4: Ask HR or Payroll in writing.

Sample inquiry: “Please confirm in writing whether the LTD insurance premiums under my plan were paid entirely by me, entirely by my employer, or jointly. Please provide my employee contribution history.”

Step 5: Ask the insurer or plan administrator.

This might be the best course of action if employment has ended or HR records are unclear.

Step 5: Keep historical records.

Employee contributions can matter years after they were made. CRA tells taxpayers to keep supporting documents concerning WLRP contributions in case it requests them later.

3. What if your employer says “We paid the premium”, but your pay stub shows a deduction?

Note: “Who paid?” can be a factual investigation, not a one-line question/answer.

1. Possible explanations:

• employer and employee shared the cost
• different disability components were funded differently
• the deduction relates to another benefit
• the employee paid for optional additional coverage
• the plan structure changed over time

2. Do not guess. Gather:

• plan documents
• pay stubs
• HR confirmation
• insurer records

4. What if the employer changed who paid the premiums?

For example:

The employer may have started out paying the premiums for several years.  Then the plan changed, with employees paying the premiums.  The reverse sequence is also possible.

CRA’s long-standing interpretation states that the tax treatment can depend on the plan in effect when the event giving rise to the disability benefits occurred, as well as on later plan changes.

If the funding arrangement changed before or during your disability, obtain individualized tax advice.  The history of the plan may matter.

5. Can your employer make LTD benefits tax-free retroactively?

Do not assume an employer can simply reclassify old premiums after a disability has occurred. CRA’s longstanding position rejects retroactively changing a plan’s tax status by adding employer contributions to employee income — later.

6. What about flexible benefits or employer “flex credits”?

Many employees choose benefits through a flexible benefits program. They may later think: “I selected LTD myself, so I paid for it” – that conclusion may be wrong.

Was the LTD coverage purchased with:

• employee payroll deductions/
• employer flex credits?
• both?

Note: CRA’s longstanding published interpretation of flexible benefit programs treats employer flex credits allocated to disability coverage as employer funding.

7. What if your employer paid the premium and you reimbursed the employer?

CRA states in its WLRP guidance that, when employees reimburse the employer for plan costs, the premiums are considered employee-paid rather than employer-paid.

Note: Documentation matters. Keep evidence showing the employee was obligated to bear the cost.

8. Does your employer’s paying LTD premiums create a taxable benefit while you are working?

Two different tax events can be easily confused. For an employer-funded group plan that pays periodic wage-loss replacement benefits:

• The employer’s qualifying premium contribution is generally not treated the same way as ordinary taxable compensation at the time it is paid.
• The periodic disability benefits may later be included in income.

The Income Tax Act specifically excludes employer contributions attributable to periodic benefits that fall within paragraph 6(1)(f) from the separate group sickness/accident premium inclusion rule.

Note: Not every employer-paid disability or sickness insurance premium receives the same tax treatment. This article is addressing group LTD income-replacement coverage.    

9. Why is tax being withheld from my LTD payments?

For a qualifying WLRP, CRA’s current payroll guidance requires income tax withholding on WLRP payments made by the employer.

Depending on who pays and on the CPP/EI treatment, the benefits may be reported on:

• T4 (Box 14, employment income)
• T4A (Code 107, wage-loss replacement plan payments)

Note: A tax slip tells you how the payment was reported.  It does not replace the need to verify the premium funding history if something appears wrong.

10. Can your employee premium contributions reduce the taxable LTD amount?

Potentially, yes.  CRA says WLRP recipients may reduce the amount reported

by contributions they made to the plan that were not previously used to reduce taxable benefits.

Caution: Do not use the same contribution twice. (CRA specifically limits the reduction to contributions not already used on a previous return.)

Collect:

• old pay stubs
• benefits statements
• employer contribution records
• previous tax returns
• prior LTD tax slips

Three examples that make the tax rule easier to understand

Example 1: Employer-paid plan

Emma’s employer pays the full LTD premium.  She later received periodic LTD payments.

General result: The benefits are taxable.

Example 2: Employee-pay-all plan

David’s employment plan requires him to pay the entire LTD premium through payroll deductions. His employer does not contribute to the plan.

General result: The benefits are not taxable under paragraph 6(1)(f).

Example 3: Shared plan

Rachel and her employer both contribute. She later receives LTD benefits.

General result: Employer participation can bring the benefits within paragraph 6(1)(f) but qualifying employee contributions can reduce the amount included in income.

Note: do not calculate Rachel’s taxable benefit simply by applying the employer’s premium percentage.

Does the same rule apply to an LTD settlement?

Not necessarily. The employer-versus-employee premium analysis is an important starting point, but settlement taxation can require separate analysis.

A settlement may relate to:

• unpaid past LTD benefits
• future benefits
• interest
• legal costs
• other damages or negotiated amounts

Read more about the tax treatment of settlements.

What about LTD back pay?

If retroactive payments replace monthly benefits that would have been taxable, tax consequences may arise. A large retroactive payment raises additional issues about:

• year of receipt
• withholding
• tax slips
• employee contribution deductions
• settlement characterization, if applicable

Speak with a tax professional before filling where substantial arrears are involved.

What about CPP disability benefits?

CPP Disability and private LTD are different benefit systems.

CPP-D can:

• have its own tax treatment
• potentially be offset against LTD under the policy
• create overpayment issues when CPP-D is awarded retroactively

Read more about CPP disability and LTD offsets.

Six common Long-Term Disability tax mistakes:

Mistake 1

Assuming all LTD payments are tax-free because they came from an insurance company

Mistake 2

Assuming all LTD payments are taxable because they replace salary

Mistake 3

Seeing an employee payroll deduction and assuming the employee funded 100% of the plan

Mistake 4

Assuming a 50/50 premium split makes exactly 50% of every benefit tax-free

Mistake 5

Throwing away old pay stubs and contribution records

Mistake 6

Assuming the tax treatment of monthly LTD automatically determines the treatment of a settlement

Your LTD premium tax checklist:

Step 1

Find the LTD policy or benefit booklet.

Step 2

Find old pay stubs showing LTD deductions.

Step 3

Ask HR who paid the premium.

Step 4

Determine whether the employer paid anything.

Step 5

Calculate or obtain your employee contribution history.

Step 6

Check whether those contributions were previously used to reduce taxable LTD income.

Step 7

Review your T4 or T4A.

Step 8

Separate monthly benefits from settlement or back-pay questions.

Step 9

Ask a qualified tax professional to confirm the final tax treatment.

When should an LTD claimant get professional advice?

It’s recommended that you seek tax advice when:

• it is unclear who paid the premiums
• employer and employee both contributed
• the funding arrangement changed
• flex credits were involved
• old contribution records are missing
• substantial LTD arrears were paid
• a settlement is being negotiated
• the tax slip appears inconsistent
• CPP-D created an LTD overpayment
• Legal fees may have tax consequences

Note: A lawyer can explain and help you deal with your LTD policy, insurer disputes and settlement structure. For individualized tax calculations and tax-return treatment, you are advised to consult:

• an accountant
• a CPA
• a tax lawyer