How Are Disability Income Benefits Taxed?
Clarify the taxability of disability income benefits. Understand how different payment sources and funding methods affect what you owe.
Clarify the taxability of disability income benefits. Understand how different payment sources and funding methods affect what you owe.
The tax treatment of disability income benefits varies significantly by source. Federal regulations and, in some cases, state laws determine the specific tax rules. This guide outlines the general tax implications for common types of disability income.
Social Security Disability Income (SSDI) benefits can be subject to federal income tax, depending on the recipient’s total income, known as provisional income. Provisional income is calculated by taking an individual’s adjusted gross income (AGI), adding any tax-exempt interest, and then adding half of the Social Security benefits received.
Two primary thresholds determine SSDI benefit taxability. For single filers, if provisional income is between $25,000 and $34,000, up to 50% of benefits may be taxable. If provisional income exceeds $34,000, up to 85% of benefits may be taxable. For married couples filing jointly, the provisional income thresholds are $32,000 to $44,000 for up to 50% taxation, and over $44,000 for up to 85% taxation. Supplemental Security Income (SSI) benefits are not taxable.
The taxability of benefits received from private or employer-sponsored disability insurance plans hinges on who paid the premiums and whether those payments were made with pre-tax or after-tax dollars. If an individual purchases a private disability insurance policy and pays premiums with after-tax money, any benefits received from that policy are generally not taxable.
Conversely, if an employer pays the premiums for a group disability insurance plan, or if an individual pays premiums with pre-tax dollars (such as through a cafeteria plan), the disability benefits received are generally considered taxable income. If both the employer and employee contribute to the premiums, the portion of the benefits attributable to the employer’s contributions (or the employee’s pre-tax contributions) will be taxable, while the portion from the employee’s after-tax contributions will be tax-free.
Workers’ Compensation benefits, which are typically paid for occupational sickness or injury, are generally not subject to federal income tax. This non-taxable status applies whether the benefits are received as weekly payments or as a lump-sum settlement. A rare exception can occur if workers’ compensation benefits reduce or “offset” Social Security Disability Insurance benefits, in which case a small portion of the workers’ compensation might become taxable.
Similarly, disability benefits received from the Department of Veterans Affairs (VA) are also generally not taxable. This includes disability compensation, pension payments, and grants for specific adaptations like homes or vehicles. These VA benefits do not need to be reported as income on federal tax returns. For state-specific short-term disability programs, such as those in California, New Jersey, New York, Hawaii, and Rhode Island, the taxability of benefits can vary by state, and recipients may need to consult state-specific guidelines or a tax professional for accurate information.