We always recommend consulting a competent CPA in regards to tax ramifications in purchasing any type of disability insurance.
Income tax on disability insurance payments depends on the type of benefit you get. It all depends on whether you paid the insurance premium with pre-tax or after-tax money, and who paid the premiums — you or your employer.
If your employer had been paying disability insurance premiums and they were not included in your gross income, the payments are taxable. Disability insurance payments are also taxable if your employer decides to pay you directly while you were disabled. However, if you paid the insurance premium with after-tax money, disability payments are not taxable. If your employer paid the premiums and you mentioned it in your gross income, disability insurance payments are exempt from taxes.
However, there can be another scenario where the employer pays part of each premium and you pay the other part with your after-tax money. In this case you will not have to pay any income tax on the disability insurance payments for your half but you will have to pay taxes on the part paid by your employer. For example, you contribute $30 each month to your disability insurance after taxes and your employer also contributes $30. A few months down the line you become disabled and you start receiving $3,000 each month as disability insurance payment. In this case since your employer paid 50 percent of the premium amount, you will have to pay income tax on the 50 percent of your disability insurance payments, which is $1,500.
On government disability insurance payments, different income tax rules apply and you can receive these payments from different programs like Veterans Administration, military or Social Security. Even workers’ compensation has different tax rules. It is always best to consult a tax professional to get complete details on income tax on disability insurance payments.
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