Insurance

Is Disability Income Taxable?

The answer to that question is – it depends.

The key question is: Who paid for the benefit? If the income is paid directly to you by your employer, it is taxable to you just as your ordinary salary would be.

Frequently, the payments are not made by the employer but by an insurance company under a policy providing disability coverage or, under an arrangement having the effect of accident or health insurance. If this is the case, the tax treatment depends on who paid for the insurance coverage. If your employer paid for it, then the income is taxed to you just as if paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it are not taxable.

Even if your employer arranges for the coverage, i.e., it’s a policy made available to you at work, the benefits are not taxed to you if you (and not your employer) pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums will be treated as paid by you. In these cases, the tax treatment of the benefits received depends on the tax treatment of the premiums paid.

For example, let’s assume that your salary is $1,000 a week ($52,000 for the year). Additionally, under a disability insurance arrangement made available by your employer, $10 a week ($520 for the year) is paid on your behalf to an insurance company. Your annual income is reported as $52,520, the $52,000 of salary plus the $520 in disability insurance premiums. Under these facts, the insurance is treated as paid for by you. So if you become disabled and receive benefits under the policy, the benefits are not taxable.

What if the facts above are the same except that the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans? In this case, your annual income would be reported as $52,000, your salary only, and any benefits you receive under the policy are taxable.

In view of the above, when you deciding on how much disability coverage you need to protect yourself and your family, you should take the tax treatment into consideration. If you’re buying the policy yourself, you only have to replace your “after tax” (“take-home”) income because your benefits will not be taxed. On the other hand, if your employer is paying for the benefit, keep in mind that you will lose a percentage of it to taxes. If your current coverage is insufficient, you may wish to supplement the employer benefit with a policy you take out on your own.

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Schanel & Associates, PA, Certified Public Accountants, located in Jupiter, FL, provides tax, accounting, and consulting services to clients in Palm Beach County, including Palm Beach Gardens, Lake Worth and Tequesta, as well as throughout South Florida and the United States.

The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.