It’s a common question for folks who need to use disability insurance: Are my disability benefits taxable?
After all, the last thing you want is to discover down the line that you owe the government for the benefits you collected while you were on disability leave.
Are Disability Benefits Taxable? Depends on Who Paid the Premiums and How
Generally speaking, if your employer pays for your disability insurance policy, your disability benefits are taxable.
The benefits you received must be reported to the IRS as income because you didn’t pay taxes on the premiums.
However, if you pay the policy premiums yourself, you’re usually paying with your after-tax dollars. In that case, you don’t have to pay taxes again on the benefits.
Here’s how the IRS answers the question, “Are disability benefits taxable?”
If both you and your employer have paid the premiums for the plan, only the amount you receive for your disability that is due to your employer’s payments is reported as income.
If you pay the entire cost of a health or accident insurance plan, do not include any amounts you receive for your disability as income on your tax return.
Remember, in order to avoid paying taxes on your disability benefits, you must have paid for the plan with post-tax dollars. A cafeteria plan could complicate things.
Sometimes employees pay their portion of a disability insurance premium with pre-tax dollars through a cafeteria plan.
If that’s the case, you will be responsible for taxes on your portion of the premium, as well. However, if your cafeteria plan uses after-tax dollars, you won’t be liable.
In addition, if you collect sick or disability pay from a state disability fund, such as California’s state disability fund or New Jersey’s State Disability Benefits plan, your disability benefits are still considered taxable.
How to Pay the Taxes
If you collect disability benefits that you owe taxes on, you can report these “earnings” via your disability plan using the W4-S tax form.
Or, if you’d rather not wait to pay the taxes back at the end of the year, you can make an estimated tax payment using the 1040-ES form.
However, keep in mind that you might have costs that can be deducted from your taxes if you itemize, including costs for medical care. These deductions could significantly reduce your tax liability.
Are My Social Security Disability Benefits Taxable?
If you collect Social Security disability, you may or may not have to pay taxes on your benefits. It depends on your income.
Here’s how the Social Security Administration answers the question, “Are my Social Security disability benefits taxable?”
If you file a federal tax return as an “individual” and your income is more than $25,000, you have to pay taxes.
If you file a joint return, you may have to pay taxes if you and your spouse have a combined income that is more than $32,000.
You may not know whether you’ll owe taxes on your social security disability until tax time the following year.
However, if you think you might come close, it would be wise to ask for taxes to be withheld from your benefits just in case.
Forewarned is Forearmed
When you’re unable to work due to disability, managing your finances can be a struggle.
A little bit of forethought and a little bit of knowledge—including the answer to the question “are my disability benefits taxable”—can help make the situation easier to manage.
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