Is Disability Income Taxable? Types of Disability Income

Disability income may be taxable, but it depends on where the benefits come from and who paid for the insurance. Most of the time, disability benefits aren't taxed, especially if you paid the premiums yourself with money that had already been taxed. But if your employer paid the premiums or if you get certain government disability benefits along with other income, some of your disability income may be taxable.

If you know how these benefits are taxed, you won't be surprised when you file your taxes. In this guide we’ll tell you when disability income is taxable, when it isn't, and how the IRS decides whether or not it is.

Is Disability Income Taxable?

Yes, depending on who paid the premiums and where the benefits come from, disability income may be taxable. The benefits you receive are typically taxable if your employer used pre-tax money to pay for the disability insurance. However, the benefits are typically not taxable if you paid the premiums yourself with after-tax funds.

If your total income exceeds specific IRS limits, some government benefits, like Social Security Disability Insurance (SSDI), may also become partially taxable.

Taxes on Disability Income

Disability income replaces a portion of your lost earnings when illness or injury prevents you from working. Because these payments are meant to replace wages, the IRS sometimes treats them similarly to regular income. But not all disability benefits are taxed the same way.

There are two main things that affect how taxes are handled:

• Who paid the premiums for the insurance?

• The kind of disability benefit you get

For instance, benefits from disability insurance that your employer pays for may be taxable, but benefits from private disability policies are usually tax-free.

Here are the most common types of disability income and how they are taxed.

Types of Disability Income

There are many places where you can get disability income:

• Disability insurance paid for by the employer

• Policies for individual disability insurance

• Disability Insurance from Social Security (SSDI)

• Supplemental Security Income (SSI)

• Disability benefits from the Department of Veterans Affairs (VA)

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What Factors Determine the Taxability of Disability Benefits?

The biggest factor that determines whether disability income is taxable is how the insurance premiums were paid.

Employer Paid the Premiums

If your employer paid the entire premium for your disability insurance and did not include that cost as taxable income on your paycheck, the disability benefits you receive are usually taxable.

This happens because the premiums were paid using pre-tax dollars, meaning taxes were never applied to that money.

Employee Paid Premiums With Pre-Tax Dollars

Sometimes employees contribute to disability insurance through payroll deductions before taxes are applied. When this happens, the benefits you receive are generally taxable because the premiums were paid using pre-tax income.

Employee Paid Premiums With After-Tax Dollars

If you pay your disability insurance premiums using after-tax money, the disability benefits you receive are usually not taxable. Since taxes were already paid on the money used to buy the policy, the IRS typically does not tax the benefits again.

Example

Imagine two employees who both receive $2,500 per month in disability benefits:

• Employee A’s employer paid the entire premium then benefits are taxable

• Employee B paid the premium using after-tax income then benefits are not taxable

Even though both receive the same benefit amount, the tax treatment is completely different.

What Is Social Security Disability Insurance (SSDI)?

The federal program Social Security Disability Insurance (SSDI) sends people who can't work because of a serious disability a check every month. The Social Security Administration (SSA) runs the program, and workers pay for it with the payroll taxes they pay while they are working.

If you can't work for at least a year because of a medical condition or if you are expected to die from it, SSDI benefits are meant to make up for some of the money you lost. 

SSDI benefits are based on your work history and Social Security contributions, which is different from private disability insurance.

Who Is Eligible for Social Security Disability Insurance?

You must meet both medical and work history requirements to get SSDI benefits.

In general, the SSA asks applicants to:

• Have a health problem that keeps them from working

• You should expect the disability to last at least a year or lead to death.

• Have enough Social Security work credits

Your income determines how many work credits you get. For instance, workers get credits every year based on how much they make at work or as a freelancer. Most people need about 40 work credits, and at least 20 of those credits must have been earned in the last 10 years before they became disabled. But younger workers might be able to qualify with fewer credits.

Family members, like spouses or children who depend on the worker, may also be able to get benefits based on the worker's eligibility.

Is Social Security Disability Income Taxable?

It's a common misconception that SSDI benefits are always tax-free. If your total income surpasses specific IRS thresholds, Social Security disability income may be subject to taxation.

Combined income, as determined by the IRS, consists of:

• 50% of your SSDI benefits

• Your gross income after adjustment

• Any interest income that is exempt from taxes

A portion of your SSDI benefits may be subject to taxation if this total income surpasses specific thresholds.

Income Thresholds for SSDI Taxation

If your income exceeds these thresholds, part of your SSDI benefits may be included in your taxable income.

How Much of SSDI Can Be Taxed?

The IRS may tax you based on how much money you make, up to half of your SSDI benefits, or up to 85% of your SSDI benefits

If a single filer makes more money that pushes their total income over $34,000, up to 85% of their disability benefits may be taxable. But it's important to remember that this doesn't mean that the whole benefit is taxed; only part of it is.

What Is Supplemental Security Income (SSI)?

Supplemental Security Income (SSI) is another federal program that helps people who are elderly, blind, or disabled and don't have much money. SSDI needs work history credits, but SSI does not. Instead, it is based on how much money you need. General tax revenues, not payroll taxes, pay for SSI.

Are SSI Benefits Taxable?

In most cases, SSI benefits are not taxable at the federal level. The IRS generally does not treat SSI payments as taxable income.

Are Private Disability Insurance Benefits Taxable?

Private disability insurance policies are typically purchased directly from an insurance company or through a financial advisor. In most situations, these benefits are not taxable because the policyholder pays the premiums with after-tax income.

However, if the premiums were paid using pre-tax income or reimbursed by an employer, the benefits may become taxable.

Because tax rules can vary depending on how the policy is structured, it’s always a good idea to review your insurance documents or consult a tax professional.

Do States Tax Disability Income?

The rules for state taxes on disability income are very different in different parts of the US. Some states follow federal tax rules, while others offer more exemptions. For instance

• Some states don't tax Social Security benefits at all.

• Some states only tax disability income above certain income levels.

• Some states use all of the rules for state income tax.

Since these rules are different in each state, it's a good idea to talk to a local tax expert to make sure you report your disability income correctly.

How SK Financial CPA Can Help With Disability Income Taxes

It can be hard to figure out if disability income is taxable, especially if you get money from more than one source, like employer insurance, Social Security, or private disability policies.

Our tax experts help people understand how disability income affects their taxes. We look at your sources of income, your filing status, and the rules set by the IRS to decide if you need to report disability benefits on your tax return.

Our team can help you with:

• How to correctly report SSDI benefits

• Knowing the difference between taxable and non-taxable disability income

• Making plans ahead of time to lower taxes

• Filling out tax returns correctly

They have helped thousands of clients over the course of more than 24 years, so they know how to explain complicated tax laws to people.

FAQs

Do I have to report disability income on my tax return?

It depends on the source of the disability income. Benefits from employer-paid disability insurance or taxable SSDI may need to be reported. If you paid the premiums yourself with after-tax money, the benefits are usually not reported as taxable income.

Is short-term disability income taxable?

Short-term disability benefits are taxable when your employer pays the insurance premiums or when premiums are paid with pre-tax payroll deductions. If you paid the premiums with after-tax income, the benefits are usually tax-free.

Is long-term disability income taxable?

Long-term disability income may be taxable if the policy premiums were paid with pre-tax dollars or by your employer. If you bought the policy yourself and paid premiums with after-tax income, the benefits are generally not taxable.

Are Social Security disability benefits taxable?

Social Security Disability Insurance (SSDI) benefits can become taxable if your total income exceeds IRS thresholds. Depending on your income level, up to 50% or 85% of the benefits may be included in taxable income.

Is disability income considered earned income?

Disability benefits are not considered earned income because they replace wages instead of being earned through work. The IRS might still see some disability payments as taxable income, though, depending on where they came from.

Do states tax disability income?

Many states follow federal rules, and they don't tax some disability benefits, like SSDI. Some states, on the other hand, have their own rules about taxes and income limits, so the way you are treated can vary from state to state.