If you're collecting short-term disability insurance benefits, the federal tax rules may require you to report the payments as income on your tax return. The rules also allow you to receive the disability payments tax-free in some cases. Regardless of whether you're collecting short-term disability because of a pregnancy, a physical injury or a mental illness, determining the tax implications depends on the type of benefit received and, if applicable, who pays the premiums.
Private and Employer-Sponsored Disability Payments
When you obtain short-term disability insurance coverage at work, whether it's because the state you live in requires your employer to provide it or it's voluntarily offered as an employee benefit, the benefits are fully taxable if your employer pays 100 percent of the premiums. If you're responsible for paying the premiums, all of your disability payments are tax-free. This can occur either through payroll deductions from your net wages – meaning the premiums are included as income on your W-2 – or by taking out a private insurance policy on your own, In the event your employer deducts the premiums on a pre-tax basis, any short-term disability benefits you collect are then taxable.
Calculating Your Taxable and Tax-Free Payments
Short-term disability benefits can be partially taxable if you and your employer both contribute to the insurance premium payments. Suppose, for example, you obtain coverage that costs $10 per month, of which you pay $4 and your employer pays $6. This provides you with $1,000 over the course of four weeks while you undergo and recover from surgery. In this scenario, 40 percent of the benefits that relate to your contribution towards the premium payments – but not your employer's -- are tax-free. In other words, $400 of your short-term disability benefit isn't taxable, while the remaining $600, or 60 percent, must be reported on your return.
Social Security Disability Insurance
The U.S. Social Security Administration provides Social Security Disability Insurance, or SSDI, for health-related problems that prevent you from working and that last, or are expected to last, at least one year. Social Security benefits aren't inherently taxable or nontaxable. Rather, it depends on how much other income you earn during the year and the filing status you use.
Other Nontaxable Short-Term Disability Payments
Other types of short-term disability benefits can be received tax-free even if you are not being responsible for paying a premium. Benefits paid under a workers' compensation law for sicknesses and injuries suffered at work, or through a “no-fault” auto insurance policy as a result of injuries sustained in a car accident that keep you from working, aren't taxable. If the short term disability relates to your military service and you receive benefits from the Department of Veterans Affairs, you don't report the payments on your tax return either.
Read More: Rules of Short Term Disability
- IRS.gov: Publication 525 – Taxable and Nontaxable Income
- U.S. Social Security Administration: Disability Planner – What We Mean By Disability
- U.S. Social Security Administration: What You Need to Know When You Get Social Security Disability Benefit
- IRS.gov: Publication 907 – Tax Highlights for Persons with Disabilities
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.