Is your short-term disability benefit payment income taxable? People begin asking this question every January as insurance companies must mail 1099 statements by the 31st of the month each year.
Most policies replace less than 70% of earnings. Every penny counts. If you filed a claim in the previous year, you may feel the negative effects when filing form 1040 by the April 15 deadline.
Disability insurance replaces income. Employers and individuals pay the premiums using before or after-tax deductions. This choice made years ago affects the additional amounts that you could owe the IRS now.
Short-Term Disability Benefit Payment Taxation
Are short-term disability benefit payments income taxable under IRS rules? The answer depends on whether you or your employer received a tax break when paying the premiums.
Your method of payment is sometimes determined by you, and other times determined by a third party: your employer or government entity.
Short-term disability for maternity leave is taxable when the employer pays the premium or the mother chooses a pre-tax deduction. Mothers receive the full benefit during maternity leave when they elect to pay post-tax or work in California or Rhode Island (see above).
The claims payment for normal labor and delivery is often much larger than the policy costs for a year. Pay taxes on the smaller amount (post-tax) rather than the bigger amount (the maternity leave benefit) to make the most of this policy purchase decision.
State temporary disability payments are sometimes income taxable. Only five states have a mandatory program, and each adopts a unique way to fund premium payments.
California state disability insurance (SDI) benefits are not subject to taxation unless your claims payment is in place of unemployment compensation. Employees pay for the program 100% by themselves using after-tax payroll deductions.
The taxability of short-term disability benefits in Massachusetts is unclear because of the different ways employers can fund premiums for the Paid Family and Medical Leave program.
- Small businesses with less than 25 employees do not have to make contributions
- Employees could deduct their share pre or post-tax from paychecks
Both pre-tax employee and employer contributions fund New Jersey state temporary disability. Therefore, the claims payment is federal taxable income. Employers must send a separate W2 statement to affected employees each year. The benefits are not subject to New Jersey state income taxes.
New York State short-term disability benefits are taxed. Both employees and employers share in funding the premiums. Claims payments are therefore subject to taxation in proportion to the employer and employee contributions – if pretax. The New York claims amount caps at $170.
Rhode Island state temporary disability benefits are not subject to federal or state income taxes. The employees do not reduce the amount of W2 income reported each year. They fund the premiums with after-tax contributions.
The taxability of short-term disability benefits in Washington State also falls into a gray area because of the different ways employers can fund premiums for the Paid Family Leave program.
- Small businesses with less than 50 employees do not have to make contributions
- Employees could deduct their share pre or post-tax from paychecks
Short-term disability benefits are taxable if your employer paid the premiums. Employers receive a tax break when they pay on behalf of employees. It is a deductible business expense.
Your claims payments will be subject to taxation in proportion to the premium funded by your employer. The insurance company may withhold an appropriate amount from your claims check and report the income to the IRS and send you a 1099 statement.
Short-term disability payments are sometimes taxable when employees pay the premiums. Employees can choose to make either pre or post-tax payroll elections (see below in the next section).
- Pre-tax: tax obligation
- Post-tax: tax-free
FICA taxes fund Social Security and come from your check pre-tax. Therefore, SSDI and SSI benefits may be subject to taxes if your income reaches above certain thresholds.
If you pre-tax the premium, the insurance company may withhold money from your claim check and send a 1099 statement. You will have to report this income on line 21 of form 1040.
Short-Term Disability Premium Tax Deductions
Are short-term disability premiums pre or post-tax? Can you deduct the costs on form 1040 when you file your personal taxes each April? The answer to these questions is it depends on your situation and preferences.
You will feel the upside of pre-taxing short-term disability premiums right away with high certainty. On the other hand, you feel the drawback in the future – if it happens at all.
The primary advantage of pre-taxing is the immediate tax reduction. The IRS rules guarantee these savings. Pre-taxing reduces your reportable W2 income, which lowers your possible exposure to three types of levies.
- Federal Income Tax
- FICA Tax
- OASDI (Social Security Disability): 6.20%
- HI (Medicare): 1.45%
- State Income Tax
The primary disadvantage of pre-taxing premiums is the possible impact on benefits in the future in event of a claim. You will owe income and FICA taxes on the payment and the insurance company will send a 1009 form to you and the IRS. Your employer must fund their half of your FICA obligation.
You may feel the upside post-tax payroll deductions for short-term disability premiums in the future. The insurance company will not have to take taxes out of your claims payment. The benefit is 100% tax-free.
The industry estimates that 1/3 of adults will experience a disability at least once in their lifetime. Most policies limit the benefit amount to 70% of income or less. You will need every penny you can get if you are out of work for an extended period.
The primary drawback of post-tax deductions is that you feel the effect right away. The premiums eat more of your take-home paycheck and discourage you from buying a policy.
Schedule A Deductions
Short-term disability premiums are not tax-deductible as a medical expense on Schedule A. IRS Publication 502 provides a list of insurance policy types you cannot include.
- Life insurance
- Providing payment for loss of earnings
- Covering loss of life, limb, sight, etc.
- Pay you a guaranteed amount each week
- The part of your car insurance that provides medical coverage
Schedule C Deductions
Short-term disability premiums are rarely tax deductible for self-employed individuals. Consult a certified public accountant before filing your return, as the IRS rules are very tricky.
- Most file as sole proprietors. A sole proprietor is personally taxed on all business income and file Schedule C (Profit and Loss from a Business). Premiums paid by a sole proprietor are not deductible.
- We see from the above that you cannot claim expenses for policies providing payment of loss of earnings. Your coverage would need to cover business overhead expenses – which is rare. It is more common with long-term policies.