Long-term disability benefits are usually taxable, but the tax depends on who paid the premiums

Whether you owe federal income tax on long-term disability (LTD) benefits comes down to one fact: who paid the insurance premiums. If your employer paid the premiums, the benefits are taxable income. If you paid the premiums with after-tax dollars, the benefits are not taxable. If you paid with pre-tax dollars through a cafeteria plan, part or all of the benefits may be taxable.

This is different from Social Security Disability Insurance (SSDI), where taxation depends on your total income. With LTD, the source of the premium payment is what matters. You will not know for certain whether you owe tax until you receive a Form 1099-R from the insurance company or your employer, which reports the taxable portion.

Most people with LTD benefits do owe tax on them, because most employer-sponsored plans are paid for by the employer. If you are unsure who paid your premiums, check your employee benefits summary or ask your human resources department.

Key Takeaways

  • Employer-paid LTD premiums result in taxable benefits; you will owe federal income tax on what you receive.
  • If you paid premiums with your own after-tax money, the benefits themselves are not taxable income.
  • Pre-tax premium payments through a cafeteria plan or Section 125 plan create a mixed situation where part of your benefits may be taxable.
  • The insurance company or your employer will send you a Form 1099-R showing the taxable amount, usually by January 31 of the following year.
  • State income tax on LTD varies by state; some states do not tax disability benefits at all.

How employer-paid premiums make LTD benefits taxable

When your employer pays the full cost of your long-term disability insurance, you receive a tax benefit at the time of enrollment: the premium is not withheld from your paycheck, and it does not count as taxable wages. This tax deferral comes with a cost later. When you begin receiving benefits, those payments are treated as ordinary income and are subject to federal income tax.

The insurance company will calculate the taxable portion and report it on Form 1099-R, which you receive by January 31. You then report this amount on your federal tax return as income. Your tax bracket and other income determine how much tax you actually owe on the benefits.

If your employer withholds taxes from your LTD payments, the insurance company will show this on the 1099-R as well. You may receive a refund if too much was withheld, or you may owe more when you file.

When you paid premiums yourself: after-tax contributions

If you paid your long-term disability premiums with after-tax dollars—meaning the money came from your paycheck after taxes were already taken out—then the benefits you receive are not taxable. You already paid income tax on that money when you earned it, so the IRS does not tax it again when you collect the benefit.

This situation is less common in employer-sponsored plans, because most employers offer the premium as a pre-tax benefit. It is more likely to occur if you purchased an individual disability policy on your own, outside of an employer plan. In that case, keep records showing that you paid the premiums with after-tax money, in case the IRS questions your tax return.

Even if your benefits are not federally taxable, you may still owe state income tax depending on where you live. A few states do not tax disability benefits at all, but most do.

Pre-tax premiums and cafeteria plans: the mixed situation

Some employers offer disability insurance through a Section 125 cafeteria plan, which allows you to pay premiums with pre-tax dollars. This reduces your taxable wages when you enroll. However, when you later receive benefits, the situation becomes complicated.

The IRS treats the portion of your benefit that came from pre-tax premiums as taxable income. The portion that came from after-tax contributions (if any) is not taxable. The insurance company must separate these two parts on your Form 1099-R and report each one correctly.

If you are unsure whether your premiums were pre-tax or after-tax, ask your employer's benefits administrator or review your pay stubs from when you enrolled. They will show whether the premium was deducted before or after tax withholding.

Form 1099-R and reporting on your tax return

The insurance company or your employer will send you a Form 1099-R by January 31 of the year after you receive benefits. This form shows the total amount you received in box 1 and the taxable amount in box 2a. Box 2b may show whether the distribution is may be able to access for special tax treatment (it usually is not for disability benefits).

You report the taxable amount from box 2a on line 5b of Form 1040 (U.S. Individual Income Tax Return) or on the equivalent line of whatever form you use. If you received benefits for only part of the year, the 1099-R will show only the amount for that period.

If the insurance company withheld federal income tax from your payments, that amount appears in box 4 of the 1099-R. This is a credit against your total tax liability. If too much was withheld, you will receive a refund when you file. If too little was withheld, you will owe more.

State income tax on long-term disability benefits

Federal tax is only part of the picture. Most states also tax long-term disability benefits, using the same rule: if the employer paid the premiums, the benefits are taxable; if you paid with after-tax money, they are not.

A small number of states do not tax disability benefits at all. These include California, New Jersey, New York, and Rhode Island, which have their own disability insurance programs. Other states may offer partial exemptions or deductions for disability income. Check your state's tax authority website or ask a tax professional about your state's rules.

Some states require the insurance company to withhold state income tax from your payments, similar to federal withholding. Others do not. You may owe state tax even if nothing was withheld, so set aside money or make estimated tax payments if you expect a large bill.

What to do if you do not receive a Form 1099-R

If you received long-term disability benefits but did not receive a Form 1099-R by early February, contact the insurance company or your employer's benefits department. The form may have been sent to an old address, or the company may not have filed it yet.

Do not file your tax return without the 1099-R if you received benefits. The IRS expects to see this form, and filing without it may trigger a notice. If the company cannot locate the form, ask them to issue a corrected one or provide a written statement of the amount you received and whether it is taxable.

If you received benefits from multiple sources (for example, both an employer plan and an individual policy), you may receive more than one 1099-R. Report each one separately on your tax return.

Frequently Asked Questions

Can I deduct long-term disability benefits as a loss on my tax return?

No. If your benefits are taxable, you report them as income. You cannot deduct them as a loss or offset them against other income. The only deduction available is if you paid premiums with after-tax money—in that case, the benefits themselves are not taxable, which is the equivalent benefit.

What if my employer paid part of the premium and I paid part?

The insurance company will calculate the taxable portion based on the share of premiums your employer paid. If your employer paid 70 percent and you paid 30 percent, roughly 70 percent of your benefits will be taxable. The 1099-R will show the exact breakdown.

Do I owe self-employment tax on long-term disability benefits?

No. Long-term disability benefits are not considered self-employment income, even if you are self-employed. You owe only ordinary federal and state income tax on the taxable portion. Self-employment tax (Social Security and Medicare tax) does not explore.

If I am also receiving SSDI, do I count my LTD benefits as income for the SSDI tax calculation?

Yes. When determining whether your SSDI is taxable, you count all your income, including long-term disability benefits. The combined total may push you over the threshold where SSDI becomes taxable. Report both the LTD and SSDI amounts on your tax return.

What happens if the insurance company withheld the wrong amount of tax?

If too much was withheld, you will receive a refund when you file your tax return. If too little was withheld, you will owe the difference. You can also adjust your withholding going forward by contacting the insurance company and requesting a change to the amount taken from future payments.