Is your short-term disability insurance claims payment 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, which the IRS taxes only one time.
There are several factors determining whether the short-term disability benefit is subject to taxation. The answer is different depending on how you paid for the coverage.
- Employer versus employee paid policies
- Maternity leave consequences
- State temporary disability programs
Income Taxation of Short-Term Disability Benefits
Is short-term disability insurance income taxable or not? You will either pay taxes on the benefit 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.
Paid by Employer
A short-term disability benefit is income taxable when your employer pays your premiums partially or fully. Many employee programs operate in this manner, and many employers elect to provide the policies as a paid company entitlement. Make sure you understand the portion your employer is paying.
Your claims payments will be subject to taxation proportionately to the premium paid by your employer. The insurance company will withhold an appropriate amount from your claims check and report the income to the IRS.
Paid by Employee
Employees pay voluntary short-term disability insurance premiums themselves. The benefits check comes income taxable if the employee paid using pre-tax deductions. In this case, the insurance company will withhold a portion of your replacement earnings, and forward it directly to the IRS.
Pre-taxing the short-term disability reduces your taxable income reported on form W2 each year. When you file your tax return in April of each year, you owe less money to the IRS. The government will want some of its money back in the event you file a claim.
In addition, your employer will need to fund their portion of FICA tax during the time you are unable to work. The carrier will send a 1099 notice to your employer.
Short-term disability benefits are tax exempt when employees pay the premiums using after-tax contributions. This costs more in the beginning but provides a much larger payout when people need to file a claim.
Maternity Leave Consequences
Short-term disability for maternity leave is not taxable when you pay for the policy using after-tax payroll contributions. If you are planning a pregnancy, you are expecting to use the benefit when you stop working to deliver your baby.
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 (the premium) rather than the bigger amount (the maternity leave benefit) to make the most of this policy purchase decision.
Tax Deductible Premiums
Self-employed workers may be eligible to use short-term disability premiums as a tax deduction. IRS instructions for form 1040 state that “You may be able to deduct the amount you paid for health insurance” on line 29.
There are precise definitions for who qualifies as self-employed. The instructions clearly allow for a health insurance deduction. The industry classifies disability insurance as supplemental health insurance – so you can make a valid argument in favor of this deduction.
Consult your tax advisor before using premiums as a tax deduction. Any claims payments would have a tax consequence.
State Short-Term Disability Benefit Taxation
People most frequently pay income taxes on state short-term disability benefits. The same rules apply as noted above, however, they come into play more frequently because workers actually have the coverage. Five states mandate coverage, which means that the majority of these workers can file a claim when they become sick or hurt.
This also means that forty-five states do not have a program. If you live in a large state such as Florida, Illinois, Ohio, Pennsylvania, or Texas you do not have to worry about the tax consequences of a temporary disability claim check – you probably will not get one – unless you purchased a private policy before getting sick, hurt, or pregnant.
California state disability temporary insurance benefits are not subject to taxation unless your claims payment is in place of unemployment insurance. Employees pay for the coverage 100% themselves using after-tax payroll deductions.
California SDI also funds the CA Paid Family Leave program, which the state classifies as unemployment compensation. Therefore, affected workers pay taxes on both forms of income replacement.
New Jersey state temporary disability is funded by both employee and employer contributions. Therefore, the claims payment is federal taxable income, but only in proportion to the contributions made by your employer. The amount subject to taxes should appear on your W2 form at the end of each tax year. The claims are not subject to New Jersey state income taxes.
New York state short-term disability benefits are taxable. Both employees and employers share in funding the premiums. Claims payments are therefore subject to taxation in proportion to the employer and employee contributions.
The New York claims amount caps at $170. Taking taxes out of such a small short-term disability check seems criminal. The amount is already woefully inadequate for workers who must pay the rent, and put food on the table while unable to work.
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.