Do You Have to Pay Taxes on Short Term Disability?

Short-term disability insurance provides income replacement if you are temporarily unable to work due to an illness or injury. The taxability of the benefits you receive is not straightforward and depends entirely on the method used to pay the insurance premiums. Understanding this distinction helps determine whether you will owe taxes on the payments.

How Short-Term Disability Premiums Affect Taxation

The Internal Revenue Service (IRS) has specific rules that connect the tax treatment of disability benefits to how the premiums are paid. If your employer pays 100% of the premium for your disability plan, any benefits you receive are fully taxable as ordinary income. This is because the premium payment is considered an untaxed benefit to the employee, so the IRS requires the eventual payout to be taxed.

A different rule applies if you pay the entire cost of the disability insurance premium yourself using after-tax dollars. Because you have already paid taxes on the money used for the premiums, the benefits you receive are not considered taxable income. This means you can receive the full benefit amount without any federal income tax liability. This is common for individual policies or for employer plans where employees pay with after-tax deductions.

Some workplace benefit plans, called cafeteria plans, allow employees to pay for benefits with pre-tax dollars. If you pay your short-term disability premiums this way, you receive an upfront tax advantage by reducing your taxable income. However, the trade-off is that any disability benefits you later receive become fully taxable.

If you and your employer share the cost of the premiums, the taxability of your benefits is proportional. Only the portion of the benefit attributable to your employer’s contribution is subject to income tax. For example, if your employer pays 70% of the premium and you pay the remaining 30% with after-tax dollars, then 70% of the benefit payments you receive would be taxable income.

Finding Your Premium Payment Details

To apply the correct tax rule, you must first determine how your short-term disability premiums were paid. The most immediate place to find this information is on your pay stub. Look for deductions labeled “STD” or “Disability,” and your pay stub should indicate if this deduction was taken from your gross pay (pre-tax) or net pay (after-tax).

Your employee benefits enrollment paperwork or the Summary Plan Description (SPD) provided by your employer are also good resources. These documents outline the specifics of your benefits, including the cost-sharing arrangement for insurance premiums. The SPD will detail the percentage of the premium paid by the employer and the portion paid by the employee.

If your pay stubs or benefits documents are unclear, contact your company’s human resources or payroll department. They can provide a definitive answer regarding your plan. You can ask if your premiums are paid with pre-tax or post-tax dollars and what percentage of the premium is covered by the company versus by you.

Reporting Taxable Disability Income on Your Tax Return

Once you have determined that your short-term disability benefits are taxable, you must report them correctly on your federal income tax return. If your disability plan is administered through your employer, the taxable benefits are included in the wages reported in Box 1 of your Form W-2.

The entity that pays your benefits, which could be your employer or a third-party insurance company, is responsible for this reporting. If an insurance company pays you directly, you may receive a Form W-2 from the insurer instead of your employer. This W-2 should be combined with any other W-2s you receive when you file your tax return.

If you anticipate that your benefits will be taxable and no taxes are being withheld, you can request voluntary withholding. To do this, file Form W-4S, Request for Federal Income Tax Withholding From Sick Pay, with the payer of your benefits. This allows you to have federal income tax withheld from your payments, which can help you avoid a large tax bill when you file your annual return.

It is important to distinguish short-term disability benefits from Social Security Disability Insurance (SSDI). SSDI is a federal program with its own set of tax rules and is reported on Form SSA-1099, not a W-2. Confusing the two can lead to incorrect tax reporting.

State Tax Considerations for Disability Benefits

The taxability of short-term disability benefits at the state level does not always mirror federal regulations. Each state has its own tax laws, and many states follow different rules. Therefore, even if your benefits are taxable on your federal return, they may not be taxable on your state return, and vice versa.

Some states have their own state-mandated disability insurance programs. Benefits from these state-run plans have unique tax rules. For instance, benefits received from some state disability insurance (SDI) programs are not subject to state income tax. This contrasts with states that tax disability income if it is considered federally taxable.

Because of this wide variation, it is important to verify the rules for your specific state. You can find this information by visiting the website of your state’s department of revenue or tax agency.