Taxation of Disability Benefits
Disability Insurance Benefit Payments
For private disability benefits, the IRS looks to tax either the premiums paid for the disability insurance or the benefits paid to the claimant, but not both. This can best be explained by example:
Some employers who usually purchase long term disability for their employees will allow employees to elect to pay for their long term disability coverage with after tax dollars through payroll deduction, just for the purpose of making any future disability benefit payments tax free. If your employer offers this alternative, it is recommended that you seriously consider taking advantage of it. Having disability benefits income tax free can greatly enhance the quality of life when income is already lowered by the disability itself.
It should be noted that there is a three year look back period to this rule. This means that once you have paid the premiums with after tax dollars for three years, your benefits will be entirely tax free. If, however, you become disabled before the three years expires, your benefits will be taxable in the same proportion as the premiums paid. If you had paid the premiums for only one year and your employer paid the two prior years, only one-third of the benefit would be tax free. These rules apply to both short-term and long term disability.
As you can see from the explanations above, the taxation of disability benefits whether from Social Security or private insurance is a complicated issue. People starting to file taxes for the first time while on disability should either retain experienced tax counsel or take advantage of one of the many programs that offer free income tax assistance.
Jacques Chambers, C.L.U., is a benefits counselor in private practice with over 35 years experience in health, life and disability insurance and Social Security disability benefits. He can be reached by phone at 323.665.2595, by e-mail at firstname.lastname@example.org, or through his Web site at www.helpwithbenefits.com.
This article was provided by Being Alive. It is a part of the publication Being Alive Newsletter. Visit Being Alive's website to find out more about their activities, publications and services.
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