Rev. Rul. 54-2

Revenue Ruling 54-1, page 29 of this Bulletin, holds the plan there involved is not a plan of insurance within the purview of section 22(b)(5) of the Internal Revenue Code. Therefore, payments received thereunder are not to be excluded from the gross income of the recipient employee unless they represent a return of his contributions to the plan. The purpose of this Revenue Ruling is to prescribe the extent to which payments from such a plan (1) constitute gross income to the employees and (2) are subject to withholding of income tax at the source on wages.

With respect to the taxability of the benefits received under such a plan, it is held that benefits equal to all of the recipient employee's contributions to the plan are excludable from gross income as a recovery of capital. To the extent that any benefits received exceed all of the employee recipient's contributions to the cost of the benefits, they are includible in the gross income of the recipient and are subject to withholding of income tax at the source on wages under section 1622 of the Code on and after January 1, 1953, as prescribed in I.T. 4107 or an and after such date an employer has been specifically notified by the Revenue Service to begin withholding, or on and after November 1, 1953, as prescribed in Revenue Ruling 209, C.B. 1953-2, 104, whichever is applicable. The employer shall withhold as follows:

1. If records of the contributions of individual employees are maintained by an employer, he shall use the records to determine what part of each disability payment is a return of an employee's contributions and is not subject to withholding under section 1622 of the Code. The amount of all contributions, whenever made, by an employee to the disability plan of his present employer shall be recovered free from taxation before there is any withholding on any disability payments.

2. In the event that records of individual employee contributions are not maintained by an employer, the employer may consider the total contributions of an employee to be the product of the amount authorized by the New York State Disability Benefits Law, i.e., one-half of 1 percent of wages not to exceed, however, 30 cents per week, 60 cents per 2-week period, and 65 cents per semimonthly payroll period, times the number of such payroll periods during which the plan has been in effect up to the date of disability.

The above conclusions are not limited to plans covered by the New York State Disability Benefits Law but are applicable as a matter of principle to plans under the laws of other States having comparable provisions.

Notice is hereby given that the Internal Revenue Service is giving further study to the method by which the amount of the employee's contribution may be determined for the purpose of excluding such amounts from withholding. The provisions of paragraph numbered 2 above represent a method which the Revenue Service will currently recognize but which is not intended as a substitute for the keeping of accurate records by employers for the future. Before reaching any conclusion as to the requirements to be prescribed, however, the Revenue Service will give consideration to any views, comments, or suggestions received by it as to the method for determining the employee's contribution not subject to tax. Such consideration is expected to include the extent to which previously computed total contributions of an employee should be reduced by nontaxable disability benefits paid to him. Also to be considered is the extent to which employees' contributions should be determined on the basis of the actual weekly or other payments made by the employee or the period of time he was actually on the payroll of the employer, rather than the maximum amount authorized during the period which the plan was in effect. All views, comments, or suggestions should be submitted before March 1, 1954, and addressed to the Commissioner of Internal Revenue, Washington 25, D.C. (Attention: T:R:I).

Pending a further issuance of a ruling on this matter, the provisions of this Revenue Ruling shall be taken to reflect the position of the Internal Revenue Service but beginning January 1, 1954, the employer shall keep records of disability benefits paid to individual employees and shall, for purposes of withholding, reduce the previously computed total contributions of an employee by the disability benefits paid to him on or after January 1, 1954, which were not taxable because they constituted a return of the employee's contributions.