INDIVIDUAL TAX BRIEF
Disability income: How is it taxed?
Many Americans receive disability income. You may wonder if — and how — it’s taxed. As is often the case with tax questions, the answer is … it depends.
The key factor is who paid for the benefit. If the income is paid directly to you by your employer, it’s taxable to you as ordinary salary would be. (Taxable benefits are also subject to federal income tax withholding, although depending on the employer’s disability plan, in some cases aren’t subject to the Social Security tax.)
Even if your employer arranges for the coverage, (in other words, it’s a policy made available to you at work), the benefits aren’t taxed to you if you pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums are treated as paid by you.
A couple of examples
Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.
Social Security benefits
This discussion doesn’t cover the tax treatment of Social Security disability benefits. These benefits may be taxed to you under different rules.
How much coverage is needed?
In deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying the policy yourself, you only have to replace your after tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes. If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out.
Contact us if you’d like to discuss this in more detail.