Your disability payments may be taxable, depending on who paid for them. Also, whether or not the insurance is paid for with pre-tax, or after-tax dollars, will impact whether disability payments are taxable. The following information examines several scenarios showing when taxes are owed on disability payments and when they are not.
Disability Payments Defined
Disability insurance replaces some, or all, of your salary if you should become unable to work. Some policies require you to be off work for a given number of days before benefit payments begin. Some narrowly define causes of incapacity that will result in payments. Regardless, disability payments can be taxable in certain circumstances.
If you pay for your own individual disability insurance policy with after-tax dollars, your disability payments are not taxable. However, you cannot deduct your premium payments as you could with health insurance.
Some employers take out individual disability insurance policies on key employees. If the employer pays for the policy and receives the benefit - being compensated for your not being there - the disability payments are not taxable and the premium is not deductible.
Some employers provide disability as part of group coverage. If you pay the premium with after-tax dollars, the disability payments are not taxable. If your employer pays the premium and does not count it as part of your taxable compensation, the disability payments are taxable.
If both you and your employer pay a portion of the disability insurance premium, the proportionate share of the disability payments covered by the employer’s contribution are taxable to you. The share you pay for, if resulting in disability payments, is not taxable.
If your payment is set up so that you are paying for your share of the disability insurance with pre-tax dollars, then any disability payments are taxable to you.
Many associations that employees of a company or self-employed individuals can join offer good rates on insurance. The rules above still hold. If you pay for the disability insurance with after-tax dollars, disability payments are not taxable.
Many employers provide so-called “cafeteria plans” where the employee can chose from among a selection of benefits and pay for them with pre-tax dollars. Under this arrangement, disability payments would be taxable.
You might qualify for a tax credit on disability payments that are taxable if you are fully and permanently disabled. This is available for those with employer-provided disability insurance for which the disability benefits are fully or partially taxable.
Many government benefit programs are affected by disability taxation regulations as well. If you earn income in addition to Social Security disability benefits, it can affect your benefits’ and taxes. Generally, workers’ compensation disability payments are not taxable, and similarly benefits from the Department of Veterans Affairs are not taxable. Finally, military disability pensions are typically taxable, but your disability payments may not be taxable if the cause of the disability was related to active service.