Are Long-Term Disability Payments Taxable?

Long-term disability is a type of financial resource for those who are unable to work due to a covered injury or illness. You or your employer may have purchased long-term disability insurance to cover these risks.

If you are unsure if you are being taxed properly or why you may be paying for benefits, turn to Pond Lehocky Giordano for guidance. We work with those mistreated or otherwise unable to recover the damages owed to them due to insurance abuses or unfair denials. Contact us for a free consultation.

When Are Long-Term Disability Payments Taxable?

There are several situations in which long-term disability payments face taxation. This determination is based on how the premium was paid, according to the IRS.

Your Employer Paid the Premium

In situations where you obtained long-term disability insurance from your employer, and your employer paid the cost of your premium, the benefits you receive are taxable. That is because the benefits you received were not included in your reported income. Therefore, you must pay taxes on the full amount that is owed to you.

You Paid the Premium with Pre-Tax Dollars

In some situations, employees will purchase long-term disability insurance and pay for it with pre-tax dollars. If you have this insurance, and you pay for it out of a payroll deduction, then the benefits you are paid are taxable. Since you purchase the policy with pre-tax dollars, you must pay for any benefits paid to you at your current tax rate.

You Purchase the Insurance Policy Outright

If you purchased your long-term disability insurance on your own, outside of your employment, or as a separate purchase with after-tax dollars, your benefits are not taxed. In most situations, your benefits are not taxable because you already paid taxes on the income that you used to purchase and maintain the policy.

Situations Where an Employer and Employee Share the Cost

It is common for employers to pay for a portion of an employee’s benefits package, and you pay the rest of the funds. This can make it challenging to know if you have to pay taxes on your benefits. However, in most situations, the portion of the benefits that are attributed to your employer’s contributions will be taxed.

For example, if your employer pays for half of your long-term disability benefits, and you pay the other half, then half of your benefits will be taxed. The portion attributed to your employee contribution, if it is made with after-tax dollars, will not be taxable.

It is important to remember that these are general guidelines. Your financial situation and the specifics about how your policy premiums are paid can make a big difference. Always discuss your tax situation with your tax advisor, who can go over the specific details of your obligations.

You Must Report Your Income

The IRS expects you to report all income you receive. This includes any income you receive for disability through an accident or health insurance plan, whether you or your employer paid for it.

In situations where you pay the full cost of a health or accident disability insurance plan, you do not need to include the amount you receive for your disability as income on your taxes. If the amount is taxable, you will need to submit a Form W-4S, Request for Federal Income Tax Withholding from Sick Pay, to the insurance company. They will then start withholding taxes to cover the estimated taxes. 

Alternatively, you can make an estimated tax payment to the IRS for the amount you are owed by filing Form 1040 ES, Estimated Tax for Individuals. The amount of tax you pay is dependent on your salary and wages paid by your employer. The same tax rate applies as if the income were received in a traditional paycheck from your employer.

Reimbursement Costs

In most situations, you can also exclude any benefits you pay that are for reimbursement of medical expenses received in situations related to personal injury or sickness under an accident or that would be covered under your health insurance. In situations where you receive income under a life insurance contract due to a terminally or chronically ill individual, you may be able to exclude those costs as well.

Lump Sum Settlements for Long-Term Disability

There are some situations in which a lump sum payment is made to settle your disability claim. This means you will not be paid over a series of months. 

It is more common for people to receive weekly or monthly payments for a set number of months. However, some policies have a lump sum that will pay all or most of the benefit due to you at one time. In these situations, the same tax rules apply. 

If the premium is paid on after-tax income – meaning you earned an income, your employer taxed it, and then the policy premium was paid – then you will not pay taxes on this lump sum. In most situations where this is not the case, you will need to pay taxes on the funds paid to you in a lump sum.

How a Long-Term Disability Lawyer Can Help You

It can be very frustrating and even overwhelming to know when you have to pay taxes and when the insurance company may not be treating you fairly. In all of these situations, you can rely on our long-term disability attorneys at Pond Lehocky Giordano to help you pursue fair treatment under the law. Contact us for a free consultation.