When Is My Disability Income Taxable?
Decipher if your disability benefits are taxable. This guide explains the factors influencing taxability for different income types and reporting requirements.
Disability income often comes with complex tax implications. Determining whether these benefits are subject to federal income tax can be confusing. The taxability of disability income is not uniform; it hinges on several factors, including the source of the benefits and who paid the premiums for any associated insurance policies.
Understanding Taxability Factors
The tax treatment of disability income depends on how the insurance premiums were paid. When an individual pays premiums for a disability insurance policy with after-tax dollars, any benefits received from that policy are not considered taxable income.
Conversely, if an employer pays the premiums for a disability plan, or if an employee pays premiums using pre-tax dollars, the benefits received are taxable. Pre-tax payments reduce an individual’s taxable income in the year premiums are paid, making the subsequent benefits taxable. If both the employer and employee contribute to premiums, or if premiums are split between pre-tax and after-tax contributions, the taxability of benefits received will be proportional to the contributions.
Taxation of Common Disability Income Types
The specific type of disability income received directly influences its tax status. Social Security Disability Benefits (SSDI) can be partially taxable depending on the recipient’s overall income. The Internal Revenue Service (IRS) calculates “combined income” by adding adjusted gross income, any tax-exempt interest, and half of the SSDI benefits received.
For single filers, up to 50% of SSDI benefits may be taxable if their combined income falls between $25,000 and $34,000. If combined income exceeds $34,000, up to 85% of their benefits may be taxable. For those married filing jointly, up to 50% of benefits may be taxable if combined income is between $32,000 and $44,000, and up to 85% if it exceeds $44,000. Supplemental Security Income (SSI) payments are not taxable.
Workers’ Compensation benefits are exempt from federal and state income taxes. These payments are considered compensation for personal injury or sickness rather than earned income. An exception occurs if a recipient also receives Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI), as a portion of the Workers’ Compensation benefits might become taxable due to an offset rule.
Employer-sponsored disability plans have tax implications tied directly to premium payments. If the employer pays all the premiums, any disability benefits received by the employee are taxable as income. If an employee pays the entire premium with after-tax dollars, the benefits are not taxable. When an employee pays premiums with pre-tax dollars, the disability benefits received become taxable. In situations where both the employer and employee contribute to the premiums, the taxable portion of the benefits is proportionate to the employer’s contribution.
Benefits from private disability insurance policies are not taxable if the individual paid all the premiums with after-tax dollars. If premiums were paid with pre-tax funds, the benefits received would then be taxable.
Military disability pensions are not taxable if the disability resulted from a combat-related injury, or if the individual qualified for disability payments before September 25, 1975, or enlisted before September 24, 1975. Disability benefits received from the Department of Veterans Affairs (VA) are tax-free. In contrast, military retirement pay based on age or length of service is taxable.
Reporting Taxable Disability Income
When disability income is taxable, recipients must report it on their federal income tax return. For Social Security Disability Benefits, recipients receive Form SSA-1099, which reports the total benefits paid during the year. The taxable portion of these benefits is then reported on Line 6b of Form 1040 or Form 1040-SR, while the gross amount is reported on Line 6a.
For taxable disability payments from employer-sponsored plans, these amounts may be included in Box 1 (Wages, tips, other compensation) of Form W-2. If receiving a disability pension from an employer’s plan, especially after reaching the minimum retirement age, the income may be reported on Form 1099-R. Taxable disability payments are reported as wages on Line 1 of Form 1040 or 1040-SR until the recipient reaches their minimum retirement age. After reaching that age, these payments are reported on lines 5a and 5b of Form 1040, as they are then considered pension or annuity income.