Most disability insurance is not taxed as income, but the rules depend on who paid the premiums

Whether you pay income tax on disability insurance depends entirely on who paid the premiums. If you paid the premiums yourself with after-tax dollars, the benefits you receive are not taxable income. If your employer paid the premiums and did not include them in your taxable wages, the benefits are taxable. If you paid premiums with pre-tax dollars through a cafeteria plan at work, the benefits are also taxable.

The IRS treats disability insurance the same way it treats other insurance: money you already paid tax on does not get taxed again when you collect. Money your employer paid on your behalf, or money you set aside before taxes, is treated as income when you receive it.

This rule applies to all forms of disability insurance — short-term disability, long-term disability, accident and health insurance, and workers' compensation. It does not explore to Social Security Disability Insurance (SSDI), which has its own tax rules based on your total income.

Key Takeaways

  • Disability benefits are taxable only if someone else paid the premiums or you paid them with pre-tax money.
  • You must report taxable disability benefits on your federal tax return as income, even if no tax was withheld.
  • Your employer or the insurance company should send you a Form 1099-R showing how much of your benefit is taxable.
  • If you are unsure whether your premiums were paid with pre-tax or after-tax dollars, check your old pay stubs or ask your employer's benefits department.

How to tell if your premiums were paid with pre-tax or after-tax dollars

The simplest way to know is to look at your pay stubs from when you were working. If disability insurance premiums appeared as a deduction before your taxable income was calculated, they were pre-tax. If they appeared after your taxable income was calculated, they were after-tax.

Pre-tax deductions usually appear in a section labeled "Pre-tax deductions," "Cafeteria plan," "Section 125 plan," or "Flexible spending account." After-tax deductions appear separately, sometimes labeled "Voluntary deductions" or "After-tax deductions." If you cannot find your old pay stubs, contact your former employer's human resources or benefits department. They can tell you whether the premiums were pre-tax or after-tax.

If you bought disability insurance on your own, outside of an employer plan, the premiums were almost certainly after-tax. You paid them with money you had already been taxed on, so the benefits are not taxable.

What happens if your employer paid all or part of the premiums

If your employer paid the premiums and did not include the cost in your taxable wages, then all of the disability benefits you receive are taxable income. You must report them on your tax return.

Some employers include the cost of employer-paid disability insurance in your taxable wages anyway. If yours did, the situation is more complicated. The portion of the benefit that came from premiums included in your wages is not taxable. The portion that came from premiums not included in your wages is taxable. Your insurance company or employer should be able to tell you what portion falls into each category.

If your employer paid part of the premiums and you paid part, the benefit is split the same way. The portion that came from your after-tax premiums is not taxable. The portion that came from your employer's premiums (or your pre-tax premiums) is taxable.

How to report taxable disability benefits on your tax return

The insurance company or your employer should send you a Form 1099-R by January 31 of the year after you received the benefits. This form shows the total amount you received and how much is taxable. Box 1 shows the total distribution. Box 2a shows the taxable amount.

You report the taxable amount from Box 2a on your federal tax return. If you file Form 1040, you report it as income on the appropriate line. If you use tax software, it will ask you for the Form 1099-R information and put it in the right place automatically.

If you did not receive a Form 1099-R but you believe your benefits are taxable, you still must report the income. Contact the insurance company or your employer to ask for the form. If they cannot provide it, report the amount you received and keep a record of your request for the form.

State income tax on disability benefits

Most states follow the federal rule: if the benefit is not taxable federally, it is not taxable at the state level. However, some states have different rules. A few states do not tax disability benefits at all, even if they are taxable federally. Others tax them the same way the federal government does.

Check your state's tax agency website or contact them directly to find out whether your state taxes disability benefits. The state tax agency can also tell you whether you need to file a state return and whether any tax should have been withheld from your payments.

What to do if tax was not withheld from your benefits

If your disability benefits are taxable but no tax was withheld, you may owe tax when you file your return. You can either pay it when you file or request that the insurance company withhold tax from future payments.

To request withholding, contact the insurance company or your employer's benefits department and ask them to withhold federal income tax from your disability payments. You can specify how much to withhold, or you can ask them to withhold based on a W-4 form. Some companies will do this; others will not. Ask what their policy is.

If you expect to owe a large amount of tax, you may also make estimated tax payments to the IRS during the year. The IRS website has a worksheet to help you calculate estimated payments.

Disability benefits and other income

If you receive other income in addition to disability benefits — such as wages, self-employment income, or investment income — your total income may push you into a higher tax bracket. This can increase the tax you owe on all of your income, including the disability benefits.

When you file your tax return, report all of your income. Tax software and tax preparers will calculate your total tax based on everything you earned. This is why it is important to report disability benefits even if you think the amount is small — it affects your overall tax situation.

Frequently Asked Questions

Is workers' compensation taxable?

No. Workers' compensation benefits are not taxable income, regardless of who paid the premiums. This is true for both federal and state tax purposes. However, if you receive workers' compensation and also receive Social Security benefits, the workers' compensation may affect how much of your Social Security is taxable.

What if I received disability benefits but never got a Form 1099-R?

Contact the insurance company or your employer's benefits department and request the form. If they say they did not issue one, ask them to confirm in writing whether the benefits are taxable. Keep that confirmation with your tax records. If you cannot get the form, report the income anyway and document your attempt to obtain the form.

Can I deduct medical expenses related to my disability?

You can deduct medical expenses on your federal tax return, but only if they exceed a certain percentage of your adjusted gross income (currently 7.5 percent). State rules vary. Consult a tax preparer or the IRS website for details on what counts as a deductible medical expense.

Does receiving disability benefits affect my tax filing status or dependents?

Disability benefits do not change your filing status or the number of dependents you can claim. However, if you support someone else and claim them as a dependent, your total income (including taxable disability benefits) affects whether you can claim them. Report all income accurately so your tax situation is correct.

What if I disagree with the taxable amount on my Form 1099-R?

Contact the insurance company or employer when ready and explain why you believe the amount is wrong. Ask them to issue a corrected form if they made an error. If you still disagree after speaking with them, you can report a different amount on your tax return and include a written explanation. Keep copies of all correspondence with the insurance company.