Content of the material
- Can you deduct disability insurance premiums?
- Pre-tax premiums on employer disability insurance makes benefits taxable
- Disability insurance premiums for private disability insurance are not tax deductible
- Are Short-Term and Long-Term Disability Premiums Tax-Deductible?
- The Benefits
- Schedule Your Consultation With an Experienced Chicago Long Term Disability Attorney
- Employee-paid insurance
- Taxation Depends on Funding and Income
- Is Disability Insurance Taxable?
- When do I pay tax on disability benefits?
- Short term disability income is usually taxed by the IRS
- Long term disability income can be taxed or not taxed by the IRS
- You may owe tax on Social Security Disability income – depending on what other income you have
- You may also owe state and local taxes
- Is Social Security disability taxable?
- How Is Short-Term Disability Taxed?
- Small Business
Can you deduct disability insurance premiums?
In many cases, you’ll have a mix of pre- and post-tax disability insurance coverage. Pre-tax disability insurance will likely come through your employer’s group plan (offered to everyone) while post-tax disability insurance is usually something you’ll buy on your own.
The tax treatment of your disability insurance premiums is an important planning consideration as it will impact whether you will owe taxes on your benefit, should you ever become disabled. A financial advisor can show you how disability insurance fits into your larger financial plan and help you anticipate the tax impact on various parts of your plan.
Pre-tax premiums on employer disability insurance makes benefits taxable
Many employers offer group disability insurance as part of your benefits package. In some cases, the premium for these plans can be paid with pre-tax dollars. This sounds like a good deal because you won’t owe taxes now on a work benefit. But if you ever need to collect your benefit, you will owe taxes on the money you receive. That means you won’t take home the entire face value of your benefit. Instead, a benefit that covers 60 percent of your income might leave you with only 40 to 50 percent of your income after taxes (or less, depending on your tax bracket).
There are also cases where you may be able to purchase additional disability coverage through your work with after-tax dollars. In that case, your benefit would be tax- free.
Disability insurance premiums for private disability insurance are not tax deductible
If you aren’t offered disability insurance through your work, or if you’re looking to supplement a work plan that only covers a portion of your salary, you can buy private coverage on your own. Like life insurance or car insurance, you can’t deduct the premiums you pay for private disability coverage. But, because you’re paying for private coverage with post-tax dollars, your benefit will be tax- free if you ever need it.
Are Short-Term and Long-Term Disability Premiums Tax-Deductible?
You cannot deduct the cost of your long-term disability or short-term disability premiums on your taxes. The IRS does not consider the cost of disability insurance to be a deductible medical expense.
Similarly, self-employed individuals cannot deduct the cost of short-term or long-term disability premiums, although business overhead insurance (that covers business expenses rather than lost income) is deductible.
Each policy has a different way of figuring out how much money you will get. Some send you a set dollar amount, while others give you a percentage of the wages you made before becoming disabled. Depending on your plan, bonuses, tips, and commissions from your job may or may not be included in the calculation of your wages.
Depending on how your disability income insurance is paid for, your benefits may or may not be taxed when you get them. If your employer paid your premium, you usually will have to pay taxes on your benefits. If you paid for an individual policy with your own taxed income, you probably won’t have to pay taxes on the benefits. Contact your income tax professional or Human Resources department for more information.
Schedule Your Consultation With an Experienced Chicago Long Term Disability Attorney
Bryant Legal Group is a Chicago-based boutique insurance litigation firm that represents policyholders in their insurance disputes. Our attorneys have decades of experience handling long-term disability disputes and have achieved significant case results for our clients.
We pride ourselves on our client-oriented legal representation, and we collaborate closely with clients throughout the dispute resolution process to ensure that we are up to date and are strategically aligned. Ready to speak with one of our disability insurance lawyers?
Employee-paid insuranceEmployees who purchase coverage through your company group plan can choose to pay with pre-tax dollars or after-tax dollars. Just as with a qualified retirement plan, if premiums are paid with pre-tax money, which gives the employee an up-front tax break, then any benefits are taxable. If premiums are paid with after-tax dollars, then all benefits received are tax-free.
Taxation Depends on Funding and Income
The source of your short-term disability payments will prove to be the most concise way to determine whether you will owe tax on this income. Generally speaking, short-term disability insurance plans that were funded using posttax dollars from either you or your employer will not be taxed. This is due to the fact the money you are setting aside for your insurance has already, in effect, been taxed by all relevant parties.
That being said, if your employer paid short-term disability coverage for you with pretax dollars, you will likely be required to pay tax on this income once you begin receiving payments.
If you are receiving income as part of Social Security disability, these funds will only be subjected to taxation if your provisional income is more than the base amount. Provisional income can best be defined as your modified adjusted gross income plus half of all Social Security benefits you receive. The base amount can be defined as an IRS-mandated income level, after which point benefits become taxable. For single filers, the current IRS base amount is $25,000. This same sum applies to individuals who are able to claim themselves as the head of their household. Couples who are married and filing jointly have a base amount of $32,000.
Using this information, you can quickly determine whether or not you will qualify for tax-free status on these funds. If you do qualify for tax-free status, you should still keep concise and accurate documentation of any payments received in the event of increased IRS scrutiny at any point.
Is Disability Insurance Taxable?
Disability benefits may or may not be taxable. You will not pay income tax on benefits from a disability policy where you paid the premiums with after tax dollars. This includes:
- A policy you bought yourself with after-tax dollars
- A employer sponsored policy you contributed to with after-tax dollars. These rules apply to both short-term and long-term disability policies. Income from social security disability isn’t taxable if your provisional income isn’t more than the base amount. Provisional income is your modified adjusted gross income (AGI) plus half of the social security benefits you received. The base amount is:
- $25,000 if you’re filing single, head of household, or married filing separately (living apart all year)
- $32,000 if you’re married filing jointly
- $0 if you’re married filing separately and lived together with your spouse at any point in the year
- Your modified AGI includes all other income without subtracting exclusions for:
When do I pay tax on disability benefits?
The rules for determining whether federal tax is owed on LTD or STD income depend on two things:
- Who paid the premiums – you or your employer?
- How were premiums paid – with pre-tax dollars or after-tax dollars?
Generally speaking, the tax rules work like this: if your employer paid the premiums, then the income you get on disability is taxable. Likewise, if you paid the premiums with pre-tax dollars, then your disability income is also taxable. However, if you paid the premiums with after-tax dollars, then your disability income payments are free from federal taxes. In other words, the IRS either takes tax upfront (before premiums are paid), or they take tax on the back-end (from your weekly or monthly disability check). That means:
Short term disability income is usually taxed by the IRS
When your employer pays for the policy (as is typically the case with STD), the IRS considers those premium payments to be untaxed income – so they take taxes on the back-end when you make a claim and get benefits. However, if you paid for some or all of the premiums with your own after-tax dollars, then that portion of the income is not subject to federal tax.
Long term disability income can be taxed or not taxed by the IRS
Long term disability income plans can be paid for by the employer, the same as STD. When the employer pays the premium, the payments while disabled will be taxable income. However, if you paid for some or all of the premium with your own after-tax dollars, then that portion of the income is not subject to federal tax.
You may owe tax on Social Security Disability income – depending on what other income you have
Is Social Security Disability taxable? The rules aren’t so simple, because it depends on the amount of other benefits you receive from the Social Security Administration (if any) plus your additional income (including sources that are usually tax free, such as U.S. Savings Bond interest). In any case, these disability benefits need to be reported on your tax return along with other Social Security income; according to the SSA website, these are the rules for determining whether and how much you’ll owe the IRS in taxes:
You will pay tax on only 85 percent of your (SSDI and retirement) benefits, based on Internal Revenue Service (IRS) rules. If you:
*Your adjusted gross income
+ Nontaxable interest
+ ½ of your Social Security benefits
= Your “combined income“
You may also owe state and local taxes
This information only applies to federal income tax; depending on where you live, your disability income benefit may also be subject to state and local taxes. To avoid unpleasant surprises, it’s a good idea to consult a local tax professional or local government tax agency.
The taxation of disability benefits is a complicated area. There are federal, state, and private disability benefits, plus two levels of possible taxation: federal and state. Let’s go through them one by one.
State taxation of state disability benefits. As to state short-term disability insurance (SDI or TDI), some states do tax their residents on these temporary disability benefits, so you got lucky. While California, New Jersey, and Rhode Island do not tax state-paid short-term disability benefits, New York and Hawaii partially tax these benefits, depending on how much your employer contributed to the cost of the insurance and how much you contributed to the cost of insurance. You can find out more in Nolo’s series of articles on state short-term disability.
Federal taxation of state disability benefits. The federal government doesn’t tax short-term disability benefits in California (unless the SDI payments are a substitute for unemployment insurance) nor in Rhode Island. The federal government will partially tax short-term disability benefits in New Jersey, New York, and Hawaii, since employers in those states pay for part of the benefit. So just because your state doesn’t tax your SDI benefits doesn’t mean the federal government won’t.
Federal taxation of federal benefits. Whether you’ll be taxed on Social Security disability insurance (SSDI) benefits depends on whether you have other income. The benefits are definitely subject to tax, but if you (and/or your spouse) have less than a certain amount of income, the federal government won’t tax them at all.
If you receive between $2,084 and $2,833 per month, counting all income, or between $2,667 and $3,666 if you’re married, then half of your Social Security disability benefits will be taxed. If you earn more than that, most of your SSDI benefits will be taxed. See Nolo’s article on Social Security disability taxation for the monthly income break points to see whether you can expect to pay taxes, and how much.
Of course, if you’ll actually be collecting disability benefits through the SSI program, these benefits won’t be taxed at all.
State taxation of federal benefits. Another wrinkle: Whether or not the federal government will tax you on your Social Security disability benefits, your state may tax your Social Security benefits. Most states don’t tax Social Security disability, but some do. Read our article on state taxation of disability benefits to see which category your state falls into.
Is Social Security disability taxable?
You might owe taxes on your Social Security disability benefits if you have other sources of income that push you within certain IRS-specified income ranges. Even then, you’ll likely only be taxed on a maximum of 85 percent of your benefits.
How Is Short-Term Disability Taxed?
Let’s say you collect $9,000 in short-term disability benefits over six months in the tax year 2021. Your employer paid half the premiums, and you paid the other half through pre-tax withholding from your paychecks. You must report the entire $9,000 as taxable income on your Form 1040 tax return. You would enter this amount on line 1 of your 2021 return, along with all other wages, salaries, or tips you earned. The taxable amount should appear on the W-2 form you received from your employer detailing all your taxable income.
You can submit IRS Form W-4S, the "Request for Federal Income Tax Withholding From Sick Pay" form, to your insurance company to have taxes withheld from your benefits. This will prevent you from ending up with a big tax bill at filing time. You can also voluntarily send estimated tax payments to the IRS to cover any taxes that will ultimately be due.
Exactly how much you'll pay in taxes on short-term disability income depends on your overall income from all sources. You'll pay a percentage of the benefits equal to your top tax bracket when you add up your total income. Here are the tax brackets for a single individual in 2021:
To continue our example above, say you earned $36,000 in salary and wages, plus $9,000 in short-term disability benefits, for a total taxable income of $45,000. The first $9,950 of your income would be taxed at 10%. Then you'd be taxed 12% on the portion of your income between $9,951 and $40,525—which includes most of your salary and the first $4,525 of your short-term disability benefits.
Finally, you'd pay 22% on the portion of your income over $40,525, which is the remaining $4,475 of your benefits.
These tax brackets pertain only to single individuals and to married taxpayers who file separate returns. Tax brackets are different and a bit more generous for taxpayers who can file as head of household and married taxpayers who file joint returns.
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