Is Disability Insurance Tax Deductible?
Disability insurance protect the incomes of workers by paying them benefits while they are out of work. These disability plans, which cover individuals for short or long periods of time, are obtained through insurers, employer or state and federal government agencies. However, the Internal Revenue Service (IRS) taxes disability benefits, depending on the workers' total incomes or how the disability plans' insurance premiums are paid.
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Social Security Disability Insurance
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The federal Social Security Administration (SSA) runs a disability program available to U.S. citizens. This program covers illnesses and injuries that are considered terminal or scheduled to last a year or longer. Workers must meet other requirements, including work longevity, sufficient earnings and enough paid into Social Security. The SSA calculates benefit amounts based on the workers' lifetime earnings; the average monthly benefit checks from Social Security in 2011 are $1,063, according to the Life and Health Insurance Foundation for Education.
Taxation of Social Security Disability Benefits
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Social Security disability benefits are taxed at normal tax rates if the incomes of the applicants top the limits set by the SSA. Individual and married couples who have incomes exceeding $25,000 and $32,000 will have half of their benefits taxed. The IRS will tax up to 85 percent of disability benefits paid to individuals if their incomes are over $34,000; for married couples the limit is $44,000.
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Individual and Group Disability Insurance
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Disability insurance plans are bought privately from insurance companies, while professional associations and employers sponsor group coverages for their members and employees. Owners of individual disability policies are in control of their coverages; they can add, delete or modify plan benefits and features for their benefit. They are also responsible for their premiums as well. Group plan decisions are made by the sponsors with no input from its members. Premiums of some group plans are shared with the sponsors, lowering the members' insurance costs. Insurers deny individual policies to applicants who are high risks, while group plans must cover all who are eligible regardless of their health conditions. Disability benefits vary by insurer but most pay insureds between 40 percent and 65 percent of their predisability salaries.
Taxation of Private and Group Disability Insurance Benefits
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Benefit payments from private and group disability plans are taxed depending on how the insurance premiums are paid. The IRS considers benefits from disability plans funded with pretax dollars taxable compensation. Examples of plans that are paid with pretax funds are group-sponsored. Coverages funded with after-tax dollars such as privately owned disability plans pay tax-free benefits to its insureds.
State Disability Insurance
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Several states provide disability insurance coverages for their workers. These disability plans are paid for through payroll taxes and pay benefits for periods ranging from several weeks to one year. Only five states sponsor disability insurance -- California, Rhode Island, New Jersey, New York and Hawaii. Benefit amounts from these disability coverages vary by state. For example, the maximum amount New York workers get is $170 per week, while Rhode Island pays individuals 4.62 percent of their predisability wages. However, because workers' insurance costs are paid with payroll taxes, benefit payments are not considered taxable income by the IRS.
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