Long-term disability (LTD) is taxable income only if your employer paid the premiums with pre-tax dollars

Whether you owe federal income tax on long-term disability benefits depends entirely on who paid for the insurance. If your employer bought the policy and deducted the cost from your paycheck before taxes were calculated, the benefits you receive are taxable income. If you paid the premiums yourself with after-tax money, the benefits are not taxable. The IRS does not tax the same dollar twice — once as a premium and again as income.

This rule applies to all long-term disability insurance, whether through an employer group plan, an individual policy you bought on your own, or a policy you purchased through a professional association. The source of the premium payment is what matters, not the source of the benefit payment or the reason you became disabled.

Long-term disability is separate from Social Security Disability Insurance (SSDI). SSDI has its own tax rules based on your combined income, and you may receive both LTD and SSDI at the same time. The two programs do not affect each other's tax treatment, though they can interact in other ways — for example, some employers reduce LTD payments dollar-for-dollar when you begin receiving SSDI.

Key Takeaways

  • Employer-paid premiums mean your LTD benefits are fully taxable; you will receive a 1099-R form reporting the amount.
  • Premiums you paid yourself with after-tax dollars mean your LTD benefits are not taxable, and you will not receive a 1099-R.
  • If your employer paid part of the premium and you paid part, only the portion attributable to employer contributions is taxable.
  • You must report taxable LTD income on your federal tax return even if you do not receive a 1099-R, and the IRS can assess penalties for unreported income.
  • Some states also tax LTD benefits, and the rules vary; check your state tax agency's guidance for your specific situation.

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

Check your most recent pay stub or payroll summary. If the premium appears as a deduction before the line labeled "Federal Income Tax Withheld" or "FIT", it was taken out pre-tax. If it appears after that line, or if you do not see it on your pay stub at all because you paid it directly to the insurer, it was after-tax.

Your employer's benefits summary or employee handbook may also state whether the plan is contributory (you pay part or all of the premium) or non-contributory (the employer pays all of it). If the plan is non-contributory, the entire benefit is taxable. If it is contributory, ask your benefits administrator or HR department what portion of the premium you paid with after-tax money — that portion of your benefit will not be taxed.

If you cannot find this information, contact your employer's benefits department or the insurance company directly. You will need this answer before you file your tax return, because the IRS will expect you to report the taxable portion correctly.

The 1099-R form and what it means

When your LTD benefits are taxable, the insurance company will send you a Form 1099-R by January 31 of the year following the year in which you received the payments. The form will show the total amount paid to you in box 1 and may indicate in box 7 whether the distribution is taxable or partially taxable.

You must attach a copy of the 1099-R to your federal tax return and report the amount in the income section. If you do not receive a 1099-R but you believe your benefits should be taxable, or if you received one but believe your benefits should not be taxable, you still must report the correct amount on your return. The insurance company's decision to issue or not issue a form does not determine your tax obligation — the source of the premium does.

If the insurance company issued a 1099-R but you paid the premiums yourself with after-tax dollars, you can file Form 8919 (Other Earned Income) or include a statement with your return explaining that the benefits are not taxable because you paid the premiums. Keep records of your premium payments to support this claim if the IRS asks.

Taxable LTD when you also receive SSDI

If you receive both long-term disability and SSDI, each is taxed under its own rules. Your LTD is taxed based on who paid the premiums. Your SSDI is taxed based on your combined income — the sum of your adjusted gross income, non-taxable interest, and half of your SSDI benefits. The two do not affect each other's tax status.

However, receiving both benefits at once can create a tax surprise. If your LTD is taxable and your SSDI is also partially taxable, your total tax bill may be higher than you expected. Some people in this situation find that their LTD payments are reduced or stopped once SSDI begins, which can actually lower their tax burden. Others continue to receive both in full. The interaction depends on your employer's plan and your SSDI award amount.

When you file your return, report your LTD on the line for taxable income and your SSDI on the line for SSDI benefits. The tax software or tax preparer will calculate the combined-income test for SSDI and determine how much of your SSDI is taxable.

State income tax on long-term disability

Most states follow the federal rule: if the premiums were paid with pre-tax dollars, the benefits are taxable at the state level too. However, some states do not tax disability benefits at all, regardless of who paid the premiums. A few states have their own rules that differ from federal law.

For example, some states exempt disability benefits from state income tax if you are under a certain age or if your income falls below a threshold. Others tax LTD only if it is paid by an employer plan, not if it is paid by an individual policy. Check your state's tax agency website or contact them directly to learn the rule for your situation. Your state may have a form or worksheet to help you calculate the taxable portion.

If you live in a state with no income tax, you will not owe state tax on your LTD benefits, but you will still owe federal tax if the premiums were employer-paid.

What happens if you do not report taxable LTD income

If your LTD benefits are taxable and you do not report them on your federal return, the IRS can assess penalties and interest. The insurance company will report the 1099-R to the IRS, and the IRS will match it against your return. If the amount on the 1099-R does not appear on your return, the IRS may send you a notice of underreported income and demand payment of the tax owed plus penalties.

The penalty for failing to report income is typically 20 percent of the underpaid tax, plus interest calculated from the original due date. If the IRS determines that the failure was fraudulent, the penalty can be as high as 75 percent. These penalties are in addition to the tax itself, so the total cost of not reporting can be substantial.

If you made an honest mistake, you can file an amended return (Form 1040-X) to correct it. The sooner you file the amendment, the less interest will accrue. If you receive a notice from the IRS, respond promptly and consider consulting a tax professional to help you resolve the issue.

How to handle estimated tax payments if your LTD is taxable

If your LTD benefits are taxable and you do not have federal income tax withheld from them, you may need to make quarterly estimated tax payments to avoid penalties. The IRS requires you to pay tax as you earn income throughout the year, not just at tax time.

To determine whether you need to make estimated payments, calculate your expected tax liability for the year based on your LTD income plus any other income you have. If you expect to owe more than $1,000 in federal income tax for the year, you should make quarterly estimated payments. You can use Form 1040-ES to calculate the amount and learn the payment important date.

Alternatively, you can ask the insurance company to withhold federal income tax from your LTD payments. This is often simpler than making quarterly payments yourself. Contact the insurance company and ask whether they offer withholding and what form you need to complete to set it up.

Frequently Asked Questions

Can I deduct my LTD premiums on my tax return if I paid them myself?

No. If you paid the premiums with after-tax dollars, you cannot deduct them. The trade-off is that your benefits are not taxable. If you paid premiums with pre-tax dollars through your employer, you cannot deduct them either — they were already excluded from your taxable income when you earned it.

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

Only the portion of your benefit that corresponds to the employer-paid premium is taxable. For example, if your employer paid 70 percent of the premium and you paid 30 percent, then 70 percent of your benefit is taxable and 30 percent is not. Ask your benefits administrator to calculate this split for you, and report only the taxable portion on your return.

Do I have to pay self-employment tax on my LTD benefits?

No. Long-term disability benefits are not considered earned income, so they are not subject to self-employment tax. This is true whether you are self-employed or an employee. However, if you have other self-employment income, you will still owe self-employment tax on that income.

If I receive LTD, can I still work and earn income?

That depends on your policy. Some LTD policies allow you to work part-time or in a different capacity and still receive benefits, while others reduce or eliminate benefits if you earn above a certain amount. Check your policy documents or contact your insurance company to learn the work rules. Any income you earn while on LTD is taxable separately from your LTD benefits.

What if the insurance company sent me a 1099-R but I think my benefits should not be taxable?

File your return reporting the correct taxable amount based on who paid the premiums, not based on what the 1099-R says. Include a statement or Form 8919 explaining why you believe the benefits are not taxable. Keep records of your premium payments. If the IRS questions your return, you can show proof that you paid the premiums yourself.