Taxes & Disability Insurance
Is Short Term Disability Insurance Income Taxable?
Is your short term disability insurance income taxable? This question is most critical to new parents taking maternity leave. Knowing the IRS rules can help you make the most of your payments.
Disability insurance replaces income and income is taxable - but only once. You will either pay taxes on the claims payment or on the premium, but never both. Your method of payment is sometimes determined by you, and other times determined by a third party: your employer, or government entity. Know the rules, and the payoffs. Make sure you file your claim properly to maximize the benefit you receive.
Your answer depends upon how the insurance premium was paid:
Disability Income Taxable for Group Plans
Short term disability income is taxable if your employer shares in the cost of your disability premium. Many group disability programs operate in this manner, and many employers elect to provide disability insurance as a paid company entitlement. Make sure you understand if your employer is paying a portion of your premium.
Your disability income will be taxable proportionately to the premium paid by your employer, and the portion paid by you using after tax payroll deductions.
Paying for Short Term Disability With After Tax Deductions
If you paid the premium entirely yourself using after-tax dollars, then your claim payment will be income tax free. This is a great way to replace more than 66% of your take home pay. Let's look at an example.
Let's say you earn $54,000 per year. Your monthly gross would be $4,500 per month, and your take home pay would be about $3,000 per month. Short term disability will replace up to 2/3 of your gross income - or $3,000 per month - equaling your take-home-pay.
Many women planning a pregnancy opt for after tax payments in order to maximize maternity leave pay. When the odds are stacked in your favor, maximize your bet.
Short Term Disability and Pretax Payroll Deductions
Short term disability insurance is taxable when you pay for the premiums using pre-tax deductions. There are many tax savings advantages to pre-taxing insurance deductions. Since short term disability insurance makes claims payments directly to you, you should understand the implications when you use the policy.
If you pay the premium with pretax dollars, your claims payment will be taxable income. Also, your employer will need to fund their portion of FICA tax during your period of disability. The insurance carrier will send a 1099 notice to your employer.
Are State Disability Payments Taxable?
Are state short term disability claims payments taxable? Only five states have a disability program in place and the answer differs for each state as the manner in which premiums are paid differ.
California state disability insurance claims are not taxable unless your claims payment is in place of unemployment insurance. The premium is 100% employee paid via after tax deductions. California SDI also funds the CA Paid Family Leave program which is considered unemployment insurance and thus is taxable.
New Jersey temporary disability is funded by both employee and employer contributions. Therefore the claims payment is taxable income, but only in proportion to the contributions made by your employer. The taxable amount should appear on your W2 statement at the end of each tax year. NJ temporary disability claims payments are not subject to New Jersey income taxes.
New York state short term disability premiums are partially funded by employees and employers. Claims payments are considered taxable in proportion to the employer and employee contributions.
Rhode Island temporary disability benefits are not subject to federal or state income taxes.