If you are getting disability your income is severely limited and taxes will pinch you . When is Long Term Disability Taxable vs nontaxable? Learn the rules of the game and understand when you will have to pay tax in this article.
According to CDC, 61 million people in the United States live with a disability. Disability can happen because of any illness or have an injury from which you are not recovering for a long time, and you cannot maintain your work life. Long-term insurance provides you income when you are disabled..
Unfortunately, the disability benefits you will be getting may be subjected to taxation, which can reduce the benefit significantly. The article discusses about long-term disability taxable versus nontaxable in detail. So, keep reading the article for more information.
What Is Disability Insurance?
Disability insurance provides you income when you are injured or have a severe illness and cannot maintain your work-life. The insurance can be offered by the Government, i.e., by Social Security Administration, or by the employer or by a private insurance company.
On average, disability insurance will only provide you with 40 to 60 percent of the income that you were getting before becoming disabled. For instance, if you earn $50,000 per year before getting disabled, then the disability insurance may provide you with $30,000 to support your family or meet medical expenditures and daily necessities.
However, the money you will be getting as disability benefits depends on your age, occupation, the insurance plan you have chosen, and other factors.
Types Of Disability Insurance
There are mainly two kinds of disability insurance.
#1.Short Term Disability Insurance
The short disability insurance will replace your pre-disabled income for a short period, i.e., for three to six months, or until you return to your work life.
The waiting period is much shorter than long-term disability benefits or Social security disability benefits. Short-term disability insurance is usually provided by your employer or through a private insurer.
#2. Long Term Disability Insurance
An accident or severe illness can change your life. If you have some medical insurance, then it will cover all your medical bills or not grocery bills. Similarly, worker’s compensation kicks in when you have severe injury or illness while working in your working organization.
Long-term disability insurance replaces 60 percent of your pre-disabled income when you cannot work for an extended period because of severe illness or injury. Long-term disability insurance lasts for 5 to 10 years and may even last for life.
You have to pay 1 to 3 percent of your annual income as premiums for long-term disability insurance. The LTD insurance is usually more expensive, but the premiums depend on your age, occupation, health status, and other factors.
You might also like to read: Long Term Disability After Termination
How Pretax Versus Post Tax Premium Payments Cause Different Disability Insurance Taxation?
- Your employer may pay a 100 percent premium on the disability insurance. The benefits which you will get will be 100 percent taxable.
- Your employer may offer cafeteria plans where you can select certain benefits like health or long-term disability insurance cost. You probably have to pay for these benefits on a pre-tax basis. Sometimes, the employer pays some percentage of the premium, and you will pay the other half either by pre-tax or post-tax dollars.
Post Tax Premium Payment Plan
- Suppose you and your employer share some percentage of the premium, and you have paid the premium after post-tax dollars. You have to pay taxes on disability benefits only on the percentage of the premium paid by your employer.
- If you pay the entire premium of long-term disability insurance after post-tax dollars, the disability benefits you receive will be 100 percent tax-free.
Pre Tax Premium Payment Plan
- Suppose you and your employer decide to have a pre-tax contribution to the premium of long-term disability insurance. In that case, the disability benefits you receive will be 100 percent subjected to taxes.
- If you individually pay all your premiums with pre-tax dollars, then the disability benefits will be 100 percent subjected to taxes.
Are LTD Benefits Taxable?
Are LTD Benefits Taxable Under Group Disability Plan?
Most employers offer group disability plans to their employees. For instance, if the employer pays all the premiums, you need to pay the income taxes based on the disability benefits you will receive through the policy.
Sometimes the premium is divided into two parts, i.e., 50 percent will be paid by your employer, and you will pay the other 50 percent. The percentage of premium that your employer pays is generally taxable. But the percentage of the premium paid by you depends on two things, i.e., whether you have paid premium pre or post-tax dollars.
Pre-tax dollars is the amount in which there is no tax deduction of state or federal taxes has occurred. Post-tax dollars is the amount in which a deduction of state or federal taxes has already occurred.
For instance, let’s say you receive long-term disability benefits of $2000 in a month where your employer pays some part of the premium, and you have paid some percentage. Suppose the employer pays 70 percent of the premium and you have paid the rest percentage, i.e., 30 percent, with post-tax dollars.
Now 70 percent of the monthly long-term disability benefits (70percent of $2000) is $1400. So $1400 is subjected to taxation. The other 30 percent of the monthly disability benefits, i.e., $600, will not be subjected to taxes because you have paid the premium after post-tax dollars.
So if you pay the premium with pre-tax dollars, then your disability benefits will be subjected to tax. Similarly, if you pay the premium of your LTD with post-tax dollars, then you don’t have to pay taxes for the disability benefits.
If you change the percentage of paying premiums, then it will significantly affect the disability taxes subjected to taxation.
What If You Have A Private Long Term Disability Policy?
A private long-term disability policy is a policy in which you independently pay your premiums so that you will get benefits when you are disabled. It means you have to pay the entire premium by yourself. Your employer is not going to pay premiums in that case.
Your disability benefits are taxable or nontaxable depending on how you pay the premiums, i.e., pre or post-tax dollars. When you pay premiums through post-tax dollars, then you do not need to pay tax for the benefits received during the disability.
The majority of the people prefer to pay premiums post-tax dollars so that they don’t have to worry about your medical expense while getting disability benefits.
What If You Take a Lump Sum Settlement On Your Long Term Disability?
Your long-term disability insurance policy may give you disability benefits in a lump sum rather than monthly payments. It means you will receive all the disability benefits in one payment.
The lump-sum disability benefits are taxable or nontaxable depending on how the premium are paid is, i.e., pre or post-tax dollars. If you pay premiums with pre-tax dollars, then there will be a significant reduction in lump sum disability benefits because of taxes.
You might also like to read: Long Term Disability Vs Long Term Care
Business Structures And Disability Insurance Taxation
#1. Sole Proprietorship -Benefits Are Nontaxable
The sole proprietorship is an unincorporated business where a single owner will pay the tax on profits earned from the business.
A sole proprietor can purchase the long-term disability insurance as an individual policy using post-tax dollars. The disability benefits provided to the sole proprietor are not subjected to taxes.
#2. Corporation- Benefits Are Taxable
The employee-owners who receive wages and W2s are employees. When the corporation pays the entire premium of the employees, then the disability benefits are subjected to taxes.
#3.Partnerships -LTD Benefits Are Taxable Or Nontaxable
The owners are not considered employees in partnership. The insurance cost for the owner is included in the gross income. Therefore the disability benefits received by them are not subjected to taxes.
But when the business pays the employees’ total premium, the disability benefits received by the employees are subjected to taxes.
#4. Key Person Disability Plans – Tax-Free To The Recipient
The employer finds a disability policy for one or numerous irreplaceable or key persons in the company. The business finds out there will be a significant loss to the organization if the valuable or critical person cannot work because of their disability.
The employer will pay premiums for those key persons, which are not tax-deductible.
What Happens If I Receive Both LTD And SSDI Benefits At The Same Time?
Suppose you receive both Long term disability benefits(LTD) and Social Security disability insurance (SDI) simultaneously. Your private insurer may deduct the amount you will receive from the Social security Administration from the LTD.
For instance, you are a dental assistant and receive $39,000 a year, But unfortunately, because of disability, you can not continue your job. The group disability pays you 60 percent of your income during the pre-disability period, i.e., $23400 per year or $1950 per month.
The SSI pays you $1000 per month as disability benefits. Now private insurance will reduce the disability benefits, i.e., it will provide you $950 per month. If your employer has paid the complete premium, you must bear 100 percent taxes on the disability benefits.
You might also like to read: Can You Get A Mortgage While On Short Term Disability?
Is Social Security Disability Insurance Taxable?
The disability benefits received from Social Security Administration are not subjected to taxes if the combined income is not more than the income limit set by the IRS or known as the base amount. The combined income is calculated as adjusted gross income, nontaxable interest, plus half of the social security disability benefits.
- If you are single or married and filing separately, then the base amount is $25,000.If the combined income is between $25,000 to $34,000, 50 percent of the disability benefits are subjected to taxes.
- If you are a married couple and filing jointly, the base amount is $32,000. If your provisional income lies within $32,000 to $44,000, then 50 percent of the disability benefits will be subjected to taxes. If the combined income goes above $44,000, then 85 percent of the disability benefits will be subjected to taxes.
Can You Deduct Long Term Disability From Taxable Income?
Many people confuse disability insurance with medical insurance and think LTD is tax-deductible as medical insurance. But no long-term disability insurance is not tax-deductible.
If you pay the premium with post-tax dollars, then you cannot claim those payments. But if you pay the premium with pre-tax dollars, then you can claim for payments.
IRS Tax Reporting Guidelines For Disability Benefits
The IRS tax classifies the long-term and short-term disability benefits as sick pay.
- If the employer pays the entire premium of the insurance, then the disability benefits will be 100 percent taxable.
- If the employer will not pay anything and the employee will pay the entire premium with post-tax dollars, then the benefits are not subjected to taxes.
- If the employee pays the entire premium with pre-tax dollars and the employer doesn’t pay the premium, then the disability benefits will be 100 percent taxable.
- Suppose the employer will pay some portion of the premium, and the employee will pay the balance with pre-tax dollars. In that case, the disability benefits will be 100 percent subject to taxation.
- Suppose the employer will pay some portion of the premium, and the employee pays teh balance with post-tax dollars. In that case, the disability benefits are taxable but only the percentage paid by the employer.
Frequently Asked Questions
#1. What is the difference between T4 and T4A?
T4 is the income slip which shows the income you have earned by working under an employer, while the T4A slip shows the income you have earned after being self-employed.
The T4 reflects the Canada pension plan and employment insurance, while T4A does not reflect it.
#2. When should T4 A be issued?
The T4A should be filed by 28th February. So it needs to be issued well in advance before that date.
#3. Are disability benefits count as gross income?
No, disability benefits are not counted as gross income. The combined income is calculated as the addition of adjustable gross income, nontaxable interest, and half of teh Social security benefits received. The combined income value will determine whether the disability benefits received by you will be subjected to taxation or not.
A Few Final Words
Disability can change your life. You may face financial hurdles during disability, like you have to bear the expenditure of medical bills, medications, and even support your family.
But doing long-term disability insurance can solve your issue. It will pay almost 60 percent of the money you receive during the pre-disability period. But you have to deal with taxes if you have paid premiums with pre-tax dollars.
We thank you for reading this article and hope we have covered everything related to taxes involved in long-term disability insurance.