NOVEMBER 2023
Welcome to this month's edition of the Tax and Business Alert. Our goal is to provide you with current articles on various tax and business topics. The articles are intended to keep you up to date on trends and issues that may impact your business and personal financial affairs.  Please contact us if you have questions about any of the issues discussed.

Previous Issue

 

IS DISABILITY INCOME TAXABLE?

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any Americans receive disability income. If you’re one of them or know someone who is, you may wonder whether it’s taxable. As is often the case with tax questions, the answer is “it depends.”

Key factor

The key factor is who paid it. If the income is paid directly to you by your employer, it’s taxable to you as ordinary salary would be. Taxable benefits are also subject to federal income tax withholding — though, depending on the disability plan, they sometimes aren’t subject to Social Security tax.

Frequently, the payments aren’t made by an employer but by an insurer under a policy providing disability coverage or under an arrangement having the effect of accident or health insurance. In such cases, the tax treatment depends on who paid for the coverage. If your employer paid for it, the income is taxed to you, as if paid directly to you by the employer. But if you paid for the policy, the payments you receive under it aren’t taxable.

Even if your employer arranges for the coverage (in other words, it’s a policy made available to you at work), the benefits aren’t taxed to you if you 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 are treated as paid by you.

Two examples

Let’s say your salary is $1,000 a week ($52,000 a year). Under a disability insurance arrangement made available to you by your employer, $10 a week ($520 for the year) is paid on your behalf by your employer to an insurance company. You include $52,520 in income as your wages for the year: the $52,000 paid to you plus the $520 in disability insurance premiums. In this case, the insurance is treated as paid for by you. If you become disabled and receive benefits, they aren’t taxable income to you.

Now, let’s look at an example with the same facts as above. Except in this case, you include only $52,000 in income as your wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by your employer. If you become disabled and receive benefits, they are taxable income to you.

Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.

Any questions?

This discussion doesn’t cover the tax treatment of Social Security disability benefits, which may be taxed under different rules. Contact us to discuss this further or if you have questions about regular disability income.

Sidebar: How much coverage is needed?

In deciding how much disability coverage you need to protect yourself and your family, take tax treatment into consideration. If you’re buying the policy, you need to replace your after-tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes. If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out personally.




Important Information: The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax—related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax—related matter addressed herein.

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