Are Disability Income Benefits Taxable?

Disability income benefits provide financial support when an individual cannot work due to illness or injury. The taxability of disability income is not uniform; it depends significantly on the source of the benefits and the specific circumstances under which they are received. Understanding these variations is important for recipients to manage their finances and comply with tax obligations.

General Principles of Taxability

The taxability of most disability benefits hinges on who paid the premiums for the insurance policy. If an individual pays premiums for a disability insurance policy with after-tax money, any benefits received are generally not taxable. This is because the funds used to pay the premiums have already been subject to income tax.

Conversely, if an employer pays the premiums, or if an individual pays with pre-tax money, such as through a cafeteria plan, the disability benefits received are generally taxable. In these scenarios, the premiums were paid with untaxed funds, so the benefits become taxable upon receipt. This distinction between after-tax and pre-tax contributions is a core concept in determining tax obligations.

Social Security Disability Benefits

Social Security Disability Income (SSDI) benefits are subject to specific tax rules. While often not taxable, they can become partially taxable depending on the recipient’s “provisional income,” also known as “combined income.” Provisional income is calculated by adding your adjusted gross income, any nontaxable interest, and one-half of your Social Security benefits.

The Internal Revenue Service (IRS) sets income thresholds for SSDI benefits.

Single Filers

Below $25,000: Generally none of the benefits are taxable.
Between $25,000 and $34,000: Up to 50% of benefits may be taxable.
Exceeding $34,000: Up to 85% of benefits may be taxable.

Joint Filers

Below $32,000: No Social Security benefits are typically taxable.
Between $32,000 and $44,000: Up to 50% of benefits may be taxable.
Exceeding $44,000: Up to 85% of benefits can be subject to federal income tax.

Supplemental Security Income (SSI) benefits, which are needs-based, are generally not subject to federal income tax.

Employer-Sponsored and Private Disability Insurance Benefits

The taxability of employer-sponsored disability benefits relates to who paid the premiums. If an employer fully pays the premiums for a disability insurance policy, any benefits an employee receives are fully taxable as income. This is because the employer’s payment of premiums is considered a tax-free benefit to the employee.

If an employee pays all premiums for an employer-sponsored plan with after-tax money, the disability benefits received are generally tax-free. When both the employer and employee contribute to the premium costs, the taxable portion is determined by the percentage of premiums paid by the employer. For example, if the employer paid 70% of the premiums and the employee paid 30% with after-tax funds, then 70% of the disability benefits received would be taxable, while 30% would be tax-free.

Private disability insurance policies purchased directly by an individual also follow the premium payment rule. If an individual pays all premiums for a private disability policy using after-tax personal funds, any benefits received are generally tax-free.

Workers’ Compensation and Other Disability Benefits

Workers’ compensation benefits received for an occupational sickness or injury are generally not taxable. This exclusion applies even if benefits replace lost wages, as they are considered compensation for personal injury or sickness. This tax-free status extends to payments for temporary or permanent disability, as well as for medical expenses.

Disability benefits paid by the Department of Veterans Affairs (VA) are also generally not taxable. This includes benefits for service-connected disabilities, dependency and indemnity compensation (DIC), and certain other VA benefits.

Military disability retirement pay has specific tax rules depending on its origin. It is generally not taxable if it stems from combat-related injuries or a specific percentage of disability determined by the VA. However, military disability retirement pay not meeting these criteria, such as that based on years of service rather than disability, may be partially or fully taxable. Additionally, payments from qualified long-term care insurance contracts are generally not taxable, up to certain daily limits, if they are for qualified long-term care services.

Reporting Disability Income on Your Tax Return

When disability income is taxable, recipients generally receive specific tax forms for reporting. For employer-paid benefits, an individual may receive a Form W-2, Wage and Tax Statement. Benefits from private disability plans might be reported on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Social Security benefits are reported on Form SSA-1099, Social Security Benefit Statement.

The taxable portion of employer-paid disability payments is generally reported as wages on Form 1040 or Form 1040-SR, line 1, until the recipient reaches their minimum retirement age. After reaching minimum retirement age, these payments are typically reported as pension or annuity income on Form 1040 or Form 1040-SR, lines 5a and 5b. The taxable portion of Social Security benefits is reported on line 6b of Form 1040 or Form 1040-SR, while the gross amount is shown on line 6a.

For taxable disability benefits not subject to regular withholding, recipients may need to make estimated tax payments throughout the year using Form 1040-ES, Estimated Tax for Individuals, to avoid potential underpayment penalties. Alternatively, some recipients might be able to adjust their tax withholding from other income sources, if applicable, to cover the tax liability on their disability benefits.