If an illness or an accident prevents you from working, your disability income can compensate for part of your lost earnings. However, depending on the type of disability insurance you are receiving, you may have to pay tax on this income.
The disability insurance tax benefits depend on the source of the disability income. The answer will change depending on whether the payments are from disability insurance, employer-sponsored disability insurance, an employee compensation plan, or a social security contract
Disability income can be a financial lifesaver if you suffer from a debilitating illness or injury. However, in some cases, the IRS may consider your disability benefits as taxable income.
You can hope that you never have to have a disability income. However, according to the Council for Disability Awareness, more than one in four people who are 20 years old today can expect to be unemployed due to a disability for at least a year before they reach normal retirement age.
If at some point in your life you have become dependent on disability benefits, you are likely to ask yourself: is disability income taxable? The answer depends on the type of benefits you’re getting, who paid for them, and how they were paid.
In this writing, we will discuss the different types of disability insurance you might receive and how the IRS handles disability payments from different sources.
What is Disability Insurance?
Occupational disability insurance is insurance that secures income in the event that an employee is unable to work due to an injury or disability.
Disability insurance can be divided into two categories:
Short-Term Disability: This insurance pays out part of your income for a short time – and can last from a few months to two years.
Long-Term Disability: This insurance begins after a waiting period of several weeks or months – and can last a few years up to retirement age.
Disability insurance can come from different sources. Disability insurance can be obtained from your employer or from insurance that you buy yourself.
Although the SSDI and SSI are government benefits from the SSA, disability insurance is a private source of income for disability. It is a type of insurance that can pay part of your salary if you are unable to work.
Employers can offer disability insurance and pay all or part of the premiums for you, but if your employer does not offer the insurance, you can get your own policy.
Related Post: 10 Best Disability Insurance of 2023
Where Does The Disability Income Come From?
Disability income can come from a number of sources, both public and private. Let’s look at two sources: social security administration and disability insurance.
Social Security
When you hear the term social security, you might automatically think of retirement savings. But the Social Security Administration (SSA) also manages two disability programs.
- Social Security Disability Insurance (SSDI) is funded from wage taxes that are withheld from employees’ paychecks or paid as part of self-employment taxes.
The benefits to which you may be entitled are based on your income or that of your spouse or parents. If you are receiving employee compensation or other government disability benefits, such as certain government and civil service benefits, your SSDI benefit amount may be reduced. - Supplementary Safety Income (SSI) is provided for eligible disabled adults and children and adults aged 65 and over with limited income and resources.
The benefits that you receive are based on the federal benefit rate, can be reduced by other types of income, and are added to all state allowances.
Some states coordinate their own disability programs with the Social Security Administration. So if your state participates, you can get state and state SSI in one monthly check.
To receive SSDI or SSI benefits, you must meet the SSA’s disability criteria. If you are 18 years of age or older, your disability must…
- there is a medically identifiable physical or mental impairment
- prevents you from engaging in “any essential gainful activity”
- It is expected to result in death
- Have lasted or are expected to last for at least 12 months without interruption.
Most people who apply for disability benefits through the SSA are not eligible. In fact, according to the SSA, on average from 2007 to 2016, only 33% of disability claims actually resulted in a payout in one year.
And the percentage of awards has been going down every year. Among those who received benefits in 2017, the average monthly amount was about $1,197.
When is the Disability Income Taxable?
Different types of disability benefits have different tax requirements as per IRS rules.
- Taxation of social security disability income
- SSI payments are not taxable.
- SSDI benefits, like other social security income, must be declared on your tax return. Whether you pay tax on these benefits depends on your total income and benefits for the year.
- You may be required to pay federal income tax on your SSDI benefits if the sum of half of all your SSA benefits other than SSI plus all other income (including tax-free interest) exceeds the base amount for your enrollment status.
- If you are married and filing a joint statement, you must calculate your total amount based on your total income and your spouse’s combined income, even if your spouse has not received any benefits.
The basic amounts are,
- $25,000 for single, householder, or eligible widow (s)
- $25,000 if you are married and separated from your spouse for the entire year
- $32,000 for joint marriage filings
- $0 if you are married apart and have lived with your spouse at any point during the tax year
SEE ALSO: Long Term Disability Insurance: How it works
Taxation of Disability Insurance
State tax rules for personal disability insurance payments depend on who paid the premiums and how they were paid.
If your employer has paid the premiums, you are usually taxable on the disability income. When you have paid the premiums, taxation will vary based on whether you paid in dollars before or after taxes.
An input tax deduction is deducted from your wages before taxes are withheld, thus reducing your taxable income. The after-tax deduction is made after the deduction of your income and wage taxes.
On the other hand, if the pre-tax dollar premium is paid, you will receive the tax break now, and any future disability payments you will receive would be taxable income.
Sometimes the employer and employee split the premium. In this case, if the employer pays part of the premium and the employee pays the remainder in after-tax dollars, only part of the payout is taxable.
These rules only apply to federal income taxes. Depending on where you live, you may also have to pay state and local income taxes on your disability benefits.
It is a good idea to check with your state and local tax authorities or your tax advisor about the laws in your area.
How is Disability Insurance Taxed?
Whether your disability income is from the SSA or an insurance policy, you can withhold federal (and possibly state) income taxes.
For SSDI, you can request the SSA to withhold tax the first time you apply, or by completing Form W-4V and choosing a withholding tax rate of 7%, 10%, 12%, or 22%.
If you receive disability benefits from an insurance company, you can request them to withhold federal income tax by completing Form W-4S.
Withdrawing tax from your monthly payment can help avoid having a tax bill come on tax day.
Remember, however, if you overpay your taxes, filing a tax return is the only way to get your overpaid amounts refunded unless you choose to use the overpaid payment as a credit towards future tax obligations to accept.
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Conclusion
When you are unable to work due to illness or injury, disability income can mean the difference between maintaining your standard of living and facing devastating financial hardship.
It is therefore a good idea to include disability insurance as part of your overall financial plan.
Customers should choose after-tax disability insurance if available through their employer.
After all, your share of the monthly premium during your working hours can be small and affordable. “If you have a disability and are limited to 60% of your normal income, you need every penny you can get.”
References
- edd.ca.gov.- Disability insurance
- hrblock.com– Is disability insurance taxable
- policygenius.com– Are disability insurance tax benefits taxable
- diservices.com– Is long term disability insurance taxable
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