The taxability of disability income benefits is a pretty simple concept to master if you pay particular attention to "who pays the premiums".

When disability benefits are received for an employer-provided disability policy, these benefits are generally included as taxable income to the recipient. If the disability benefits are received from a policy where the individual made the premium payments, then the benefits are excluded from taxable income. Some hybrid disability policies exist; whereas, part is provided by the employer and the other part by the individual- in this case benefits will be includible in income to the extent of the employer pro rata share of premiums.

Structure of Disability Contract Tax Consequence of Premium Tax Consequence of Benefits Paid

Type A:
Individually Owned
Employer pays premiums
Tax Deductible by Employer Taxable to Individual

Type B:
Individually Owned
Individual pays premiums
Non-Deductible by Individual Tax Exempt to Individual

Practice Question:
Jim has a salary of $70,000 with Widget Corporation (S Corporation) which puts him in the 25% tax bracket. His employer gives Jim a bonus in the form of the cost of disability insurance (premium $4,000) which is added to Jim's W-2. If Jim becomes totally disabled, he is entitled to 60% of his salary in disability benefits. What is Jim's after-tax monthly disability benefit if he is in the 15% tax bracket during his disability?

A. $2,625
B. $2,975
C. $3,000
D. $3,500

Answer: D
Jim's employer pays Jim a bonus of $4,000 which is applied directly to disability premiums on an individual disability policy for Jim. Jim's W-2 income will reflect $74,000. Therefore, Jim will pay tax on the premium payments and is considered the premium payer and therefore will not be taxed on the monthly disability benefits. He would receive $3,500 per month tax-free ($70,000 x 60% divided by 12 months).


Introduction to Long Term Care

Related Articles
  1. Financial Advisor

    How to Help Clients Who Have Become Disabled

    Disability can strike a client any time. Advisors should make sure clients are adequately insured against this risk and know what benefits are available.
  2. Insurance

    Protecting Your Income With Disability Insurance

    For a high-earning professional, income protection is essential. Here's what to look for in a disability insurance policy.
  3. Retirement

    Do You Qualify for Social Security Disability?

    When it comes to qualifying for Social Security Disability Insurance, you either do or you don’t. Here's how to find out if you do and how to apply.
  4. Managing Wealth

    Top 6 Features Of A Great Disability Policy

    Many people consider buying life insurance, but few think to prepare themselves from long-term illness or disability. Find out how to shop for disability insurance and protect yourself from financial ...
  5. Financial Advisor

    Disability and Retirement: How to Be Prepared

    Here's how financial advisors can help clients with disabilities arrive at the best solution over the long term when it comes to planning for retirement.
  6. Taxes

    The New Tax-Free Savings Accounts For the Disabled

    Due to the Achieving a Better Life Experience (ABLE) Act, many people with disabilities will have an easier time financing their lives, starting in 2016.
  7. Financial Advisor

    Top 3 Financial Steps to Take on Disability

    Going on disability can be a stressful time financially. Here are 3 steps to take on disability to help protect against significant financial blowback.
  8. Retirement

    What If Social Security Disability Runs Out Of Money?

    The social security disability program is nearly bankrupt and could run out of money by 2016.
  9. Personal Finance

    Why Having an Emergency Fund Is Essential

    Do you know how you’d pay the bills if you lost your job, had a health crisis or needed a major car repair? That's why an emergency fund is essential.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center