Are Short- and Long-Term Disability Benefits Taxable?

Aug 26, 2020 | Blog |

Whether you’re interested in submitting a claim for long-term disability benefits, are currently involved in a disability insurance dispute, or are already getting benefits, chances are you’ve at least considered the tax consequences. Unfortunately, there’s no simple answer to the question, “are short- and long-term disability benefits taxable?.” Instead, it depends on your circumstances.

At Bryant Legal Group, we’ve spent decades helping people navigate their disability insurance claims. In this blog, we’ll discuss the factors that will impact your long-term and short-term disability benefits’ taxability.

Basics of Long-Term Disability Income Taxation

The IRS addresses disability insurance benefit payments in Section 105 of the Internal Revenue Code. As with many tax laws, the taxability of both long-term and short-term disability benefits depends on a variety of factors. However, the most important factor is whether you paid your premiums with pre-tax or after-tax dollars.

  • Pre-tax dollars: If you paid your premium with pre-tax income, you’ll typically have to pay taxes on any benefits you receive from the plan.
  • After-tax dollars: If you made payments with after-tax dollars, you might not have to pay taxes on your disability insurance benefits later on.

It’s worth noting that your long-term disability benefit is already likely to be a percentage of your pre-disability earnings. Because your benefit payments are also taxable, you’ll get less money in your pocket. We encourage people, especially highly compensated professionals, to be wary before they purchase a plan with a pre-tax premium structure.

Most people with private or individual disability insurance plans use after-tax dollars when they purchase their plans. However, the story is much more complicated if you have employer-sponsored disability insurance coverage.

Are My Employer-Sponsored Long-Term Disability Benefits Taxable? It Depends

Many employees have a patchwork of disability insurance as part of their fringe benefits package. Your employer may offer you a limited amount of short-term disability and long-term disability coverage that is fully covered by the company. Or, you may pay a portion of your disability insurance premium while your employer subsidizes the rest. Each of these situations can result in different tax consequences.

Let’s walk through some common situations.

Your Employer Paid Some or All of Your Disability Insurance Premiums

If your employer pays your entire disability insurance premium, you’ll typically have to pay income taxes on any benefits you receive. However, if your employer pays just a portion of your premium, the taxability of your benefit payments will depend on whether you paid the rest of your premium with pre-tax or after-tax dollars.

You Paid Premiums with Pre-Tax Dollars

If your employer paid part of your disability insurance premium, and you paid the rest with pre-tax dollars, then your entire disability benefit payment is taxable income.

You Paid Premiums with After-Tax Dollars

If you paid your share of an employer-sponsored long-term disability premium with post-tax dollars, then only part of your disability insurance payments is taxable.

For example, suppose your employer pays 60% of your disability insurance premium. You pay the remaining cost with after-tax dollars. In this case, you’ll only have to pay taxes on 60% of your long-term disability benefit payments.

What Happens if I Get a Disability Insurance Settlement or Negotiated Buyout?

If you and your insurer negotiate a buyout of your long-term disability benefits, you’ll receive the agreed-upon lump sum amount at once. We recommend seeking the advice of an experienced tax professional regarding the taxability of payments beyond regular monthly benefits and potential deductions for attorney’s fees and associated expenses.

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.

Have Specific Questions About the Taxability of Your Disability Benefits? Consult With a Professional

Navigating the U.S. Tax Code isn’t an easy process. If you need help selecting the right disability insurance plan or have questions about your policy’s tax consequences, you should consult both a disability insurance attorney and a tax professional.

At Bryant Legal Group, we help professionals, self-employed individuals, and entrepreneurs with their complex disability insurance issues. Whether you have questions about a private disability insurance plan you’re considering, need to apply for long-term disability benefits, or are facing an appeal, we can help you understand your legal options. We can also suggest reputable tax professionals who can address your specific IRS concerns.

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? Call us at (312) 561-3010 or complete our online form to schedule your free initial consultation.

Resources

20 U.S.C. §105. Retrieved from https://codes.findlaw.com/us/title-26-internal-revenue-code/26-usc-sect-105.html

The content provided here is for informational purposes only and should not be construed as legal advice on any subject.

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