Long-term disability income insurance (LTD) replaces a portion of a person’s former income if the individual becomes unable to work. Whereas individual wages earned from working are typically subject to state and federal income taxes for the year in which the wages are earned, however, the tax implications of LTD benefits can be different depending on how the premiums were handled while the individual was still working.
The answer to the common question, “Are long-term disability payments taxable?” can therefore have more than one answer. Understanding LTD income tax rules while you are still healthy and working can put you in a position to structure your potential long-term disability taxes later, should you ever need disability benefits. If you are already receiving LTD benefits, then evaluating the tax aspects of long-term disability benefits in your situation can help you avoid tax compliance failures and minimize your stress.
Is Long-Term Disability Imputed Income?
Imputed income is a term that individuals planning their long-term disability financial management strategies may encounter in a couple of different contexts. The first is family law court, while the second of course is LTD income tax rules. People who have questions about the tax aspects of long-term disability benefits often have questions about a number of other financial complications that may involve those same LTD benefits, so it is useful to understand both of these settings for imputed income.
Imputed Income: LTD Benefit Payments, Child Support, and Family Law Courts
People who file, or are suspected of filing, incomplete or inaccurate financial disclosures in a divorce or child support case may have their incomes imputed by the court. In this case imputed income is usually based on the last known income of the person to whom it is imputed. Sometimes the court may instead impute an amount that more closely reflects the individual’s documented earning power, especially if there is evidence to suggest that an individual may have deliberately reduced his or her income in an attempt to skew the division of property in a divorce case or lower child support obligations.
If you are paying child support or going through a divorce and concerned about the tax aspects of long-term disability benefits, this may mean that you need to report any change in the amount of your LTD benefit to the court overseeing your family case. Divorced parents who were ordered to pay child support while they were still working and who are now receiving LTD benefits may also need to file a motion to modify child support based on their change in circumstances. The court will usually provide forms directing how you report your income, so you may need to confirm the tax implications of LTD benefits in your case to determine whether you should include calculations for long-term disability taxes to accurately reflect your new income.
Imputed Income: Employee Benefits and Total Compensation
The other way that people dealing with LTD income tax rules may encounter the term imputed income is in relation to their employee benefits. When an employer pays some or all of a long-term disability policy premium on your behalf, that employee benefit may be reported by your employer as “imputed income” and included in your total compensation. Like several other benefits that are not paid directly to employees in the form of money, but that nonetheless constitute an important aspect of the “total compensation” they receive for their work, the premiums paid on your behalf are generally considered taxable income under Internal Revenue Service (IRS) LTD income tax rules.
For individuals wondering, “Are long-term disability benefits taxable?” what these imputed income rules mean for the tax implications of LTD benefits is that the value of the premium payments your employer has contributed to your long-term disability policy will need to be taxed at some point. If the employer reports that value as imputed income on your annual W2 form, then it is considered already taxed and you will not normally need to pay long-term disability taxes on any benefits received under the policy. If the employer does not include the value of the premium payments made on your behalf as part of the total compensation reported on your W2, then your LTD benefits will normally be taxable income.
Why Is My Long-Term Disability Not Taxable?
If you are wondering, “Are long-term disability payments taxable?” you may find it helpful to think about the tax implications of LTD benefits less in terms of whether disability payments are taxed, and more in terms of when. LTD income tax rules can be complicated, but the general principle that guides most of the tax aspects of long-term disability benefits is that all income needs to be subject to income tax at some point, but most income should only be subject to income tax once, at least at the federal level.
Tax Implications of LTD Benefits: Premiums Paid by Employer
If your employer paid the full cost of premiums on your behalf and reported those benefits as imputed income on your W2 forms while you were working, then in general the benefits you receive under that same plan in response to an approved long-term disability claim will be considered tax-exempt under federal LTD income tax rules. If your employer paid the full cost of premiums on your behalf and did not report the value of those premiums as imputed income on your W2 forms while you were working, then the benefits themselves will usually be taxable if you receive payments for a long-term disability claim.
Tax Aspects of Long-Term Disability Benefits: Individual LTD Policies
If you purchased an individual long-term disability policy and paid for the premiums yourself, using money on which you had already paid federal income taxes, then usually the IRS will not consider any benefits you receive from that policy after filing a claim to be taxable as new income. This aspect of LTD income tax rules essentially helps to prevent a situation in which a single individual pays income tax twice on the “same” income: as earnings used to purchase premiums, and again as the benefits purchased with those premiums.
Premium Payment Shared Contributions: Are Long-Term Disability Payments Taxable?
If your long-term disability insurance policy is part of a group plan sponsored by your employer, but the employer contributed only a portion of the premiums, then this cost-sharing arrangement can result in some additional complexity for your long-term disability taxes. If the employer’s portion of the premiums was imputed as part of your total compensation while you were working for the company, and your portion of the premium cost was paid with after-tax dollars, then the benefits will usually be exempt from income taxes, at least at the federal level. If your portion of the premium cost was paid with withholdings before taxes, or your employer did not impute the value of the premiums on your W2 forms as gross income, then you can probably expect to the tax implications of LTD benefits to be the same as they would be for any other type of income in the year when you receive them.
Is Long-Term Disability Before or After Tax?
LTD income tax rules can admittedly be complicated. Although many people find the tax aspects of long-term disability benefits challenging to navigate, the general principle that typically aspects most of the tax implications LTD benefits is that when premiums are taxed, then the person who receives benefits under the policy will not owe long-term disability taxes on those benefits. This is true whether the premiums were paid by an employer and reported as part of the employee’s gross income or paid by the policyholder with net income that had already been subject to income tax withholdings.
Tax Implications of LTD Benefits After Untaxed Premiums
If the premiums were not already subject to taxes, typically because the employer did not impute them as gross income, as in the employee’s total compensation, then the benefits themselves will be considered taxable income in the year the policyholder receives the payments. For many people, this system will be familiar as similar to the way retirement benefits are paid under many employee retirement plans: Benefits that have not previously been taxed are generally treated as part of an individual’s taxable income for the year in which the benefit payments are received as income.
Tax Aspects of Long-Term Disability Benefits With Employer-Employee Contributions
The more complicated situation for long-term disability taxes can arise when the employer and the policyholder each paid a portion of the total premium cost, particularly if one side’s contribution was paid with before-tax dollars and the other side’s portion was paid with income received after taxes. Even so, LTD income tax rules will still generally operate on the presumption that long-term disability should only be assessed on the portion of a benefit attributable to previously untaxed premiums. Consider consulting with a disability attorney or an accountant in your area if you have concerns about how to parse these proportions.
Do You Pay Taxes on LTD Benefits?
The tax implications of LTD benefits can vary, but in most cases the answer to “Are long-term disability payments taxable?” will depend on how the premiums were paid. LTD income tax rules hold that when the premiums are paid with after-tax dollars, then the benefits are generally not treated as taxable income for the year in which they are received. Do not forget, however, that if you are receiving Social Security disability you will still need to include the income from your LTD benefits in your reporting to the Social Security Administration. Always review your policy terms outlining the tax aspects of long-term disability benefits to be sure you know what to expect, and consider speaking with a professional for additional advice and assistance.
Know What to Expect and When to Ask for Help
Understanding the tax implications of LTD benefits is essential for accurate financial planning and avoiding surprises at tax time. Whether your benefits are taxable largely depends on how your premiums were paid, and by whom. Knowing these distinctions can help you prepare for what to report to the IRS, your state tax authority, or the Social Security Administration. If your situation involves a mix of premium sources or unique circumstances, don’t hesitate to seek guidance.
2 Responses
My comment is a question – I have an employer sponsored group disability insurance policy. The employer pays the premium. The benefits are fixed by the policy at 50% of my employee compensation . In addition, I purchased the additional coverage which I paid for out of my after tax dollars. Purchasing the additional disability coverage entitled me to receive a disability benefit in total of 65% of my employee compensation. Thus the additional disability coverage added a fixed 15% on to the disability compensation I was to receive. I became disabled and I am maintaining that the taxable portion of the benefit I received is 50/65 = 76.92 % of the benefit receive as the benefit %s are fixed by the policy. I maintain that the non taxable portion of the benefit is 15/65 = 23.08 % of the total benefit I receive, which again, is fixed by the policy. The premiums paid are not fixed but set by the insurance company and they fluctuate from year to year. Sometimes my portion increases of the premium that I pay for the additional 15% benefit goes up and sometimes the employers portion decreases but the portion of the benefit amount to be received in the event of disability stays fixed and constant as stated in the policy. Since Ive already paid taxes on the money used to pay the premiums for the 15% benefit, the benefits received should not be subjected to double taxation. The benefits I receive per the amount that I pay per the policy are separately stated as the additional 15%. Since my employer pays for the fixed 50% of the long-term disability insurance benefit, shouldnt that portion be considered the taxable portion of the income since thats the benefit that is deemed to be a replacement of my salary. The premiums change every year but the benefit paid is fixed by the policy as a percentage of compensation regardless of whether my premium is more or less relative to the employers premium. This change and the percentage of the premium that it represents does not effect the amount or proportion of the benefit to be paid – cause no matter what the premiums are 50% of compensation is the benefit paid that is attributable to the employer contribution and 15% is the additional amount of benefit attributable to my contribution. Why would the taxable and non taxable amounts in this case be determined by the relative percentage of the premium paid by myself and my employer versus the fixed benefit received as set forth in the policy itself. The benefit wouldnt change even if the amount of the premium fluctuates and the proportions of what I paid and my employer paid changed. In my view, in these circumstances, the premium percentages shouldnt determine the taxability and non taxability of the benefits being received. What do you think ? Do I have a leg to stand on ?
The specifics and circumstances of each tax situation warrants a review with a professional tax advisor and will be different depending on location. I would recommend pointing the questions to a qualified CPA in your area.