Tough One Re Disability Insurance

[ERISAgeek111]

A client - a 501(c)(3) entity - has a contract with a local medical school pursuant to which school faculty (employed by the school) provide clinical services (treat patients) on the premises of this client.  The faculty providing the services assign their right to send their bills for services to my client, meaning the client bills the patients and receives payment.  The arrangement is that the faculty providing the clinical services gets paid 45 cents on $1 for each service provided, the rest of the money goes to support various departments of the 501c3.  The way the money collected is actually paid to the faculty/physicians is that, after my client collects the payments, it wires a lump sum to the medical school, with a list of which faculty/doctors to distribute payments to.  There is no 1099 or W-2 from my client (the 501c3).  Instead, the faculty/doctors get paid from the medical school through their regular pay stub/W-2 with an entry that says "clinical earnings".   

My client wants the medical school to contract with an insurance company to provide disability insurance to the clinical faculty.  Medical school wants nothing to do with it.  Is there a group that can be joined to allow for the provision of this disability insurance to the clinical faculty? The medical school does not want to pay the premiums, but the 501c3 client offered to cover the cost out of their reserves.  My client wants the disability benefits to be tax-free to the faculty/physicians; however, in order to do so, the premiums would have to be paid with after-tax dollars.  So for example, if the medical school agreed to do it, the medical school pays $100 for disability premium for an employee, that is then added to the employee's income, the employee than pays tax on regular salary plus the $100, and subsequently, the disability benefits are tax-free to the employee (because tax already paid on the $100).    

Is there a way that my client can pay these disability premiums? They are offering to do so.  So in other words, since the medical school doesn't want to be involved with this, can my client, the 501c3, somehow (maybe before releasing the money to the medical school) pay the disability premiums for the faculty/physicians, then issue them  a 1099 reporting it as additional income to them, such that the faculty/physicians pay tax on that extra income, and thus the benefits become tax free?  Is something like this permissible?  

I welcome any suggestions at all.  I have zero ideas.  Thanks.  

[Luke Bailey]

ERISAGeek111, ERISA and the Code may not be your biggest issues. Let me point out a couple of other issues. I don't know all your actual facts, so I will treat your question as a hypothetical.

First, you would want to disclose the facts to the insurance company issuing the policy and make sure there is no mismatch between the facts and the policy language. Group disability insurance policies usually identify an "employer" as the owner of the policy and the workers as "employees," and then, e.g. in partnerships, identify the partners as "employees." So if the medical school  really wants nothing to do with this and is not willing to be identified in the policy as the employer, it could get complicated from the point of view of policy language. Also, for determining the benefit, is it just "earnings" from the 501(c)(3) or from both the 501(c)(3) and the school?

Second, the 1099-MISC would, I think, imply that there is a direct service relationship between the doctors and the 501(c)(3). Would want to run that by employment law, health law, etc. experts, and the folks that worked out the current arrangement in the first place, since what is being proposed seems somewhat inconsistent with it.

[ERISAgeek111]

Thanks Luke.  Do you see any ERISA/tax code issues here? I really can't think of many.  I agree the insurance policy is likely to reference an "employer" as the owner of the policy, hence the 501c3 could not be the owner of the policy, but what if the 501c3 pays them some sort of a "bonus" (although there is no employer-employee relationship) and the employee uses that bonus to buy their own insurance? Employee gets a 1099 as relates to the bonus and reports the amount as income, so it's taxable, hence any benefits subsequently received are tax free?  I agree that the 1099 implies a service relationship.  Right now, the employer (the med school) pays and just reports the additional earnings as "clinical services".  I believe that part goes in a different box on the W-2 (not box 1), but haven't confirmed.  

Any thoughts welcome.  

[Luke Bailey]

ERISAgeek111, my only additional thoughts are that it is many-faceted and fact-based. Good luck.