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This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma Tax®.
Disability income can be a financial lifesaver if you suffer from a debilitating illness or injury. But in some cases, the IRS might view your disability benefits as taxable income.
You may hope you never have to receive disability income. But more than one in four people who are age 20 today can expect to lose at least a year of work because of a disabling condition before they reach normal retirement age, according to the Council for Disability Awareness.
If you do need to rely on disability benefits at some point in your life, you’ll likely wonder: Is disability taxable income? The answer depends on the type of benefits you receive, who paid for them and how they were paid.
Let’s break down some of the types of disability income you might receive and how the IRS treats disability payments from different sources.
- Where does disability income come from?
- When is disability income taxable?
- How is tax withheld on disability benefits?
Disability income can come from multiple sources, both government and private sector. Let’s look at two sources: the Social Security Administration and disability insurance.
When you hear the term Social Security, you might automatically think about retirement benefits. But the Social Security Administration, or SSA, also manages two disability programs.
- Social Security Disability Insurance, or SSDI, is funded by the payroll taxes withheld from workers’ paychecks or paid as a part of self-employment taxes. The benefits you may be eligible to receive are based on your earnings or the earnings of your spouse or parents. If you receive Worker’s Compensation or other public disability benefits such as certain state and civil service benefits, your SSDI benefit amount may be reduced.
- Supplemental Security Income, or SSI, is for eligible disabled adults and children and adults 65 and older who have limited income and resources. The benefits you receive are based on the federal benefit rate, may be reduced by other forms of income you receive, and will be added to any state supplement you may receive. Some states coordinate their own disability programs with the Social Security Administration, so if your state participates, you could receive federal and state SSI in one monthly check.
To receive SSDI or SSI benefits, you must meet the SSA’s disability criteria. If you’re 18 or older, your disability must …
- Be a medically determinable physical or mental impairment
- Prevent you from engaging in “any substantial gainful activity”
- Be expected to result in death
- Have lasted or be expected to last continuously for at least 12 months.
Most people who apply for disability benefits through the SSA won’t qualify to get them. In fact, In fact, on average from 2007 to 2016, just 33% of disability claims in a year actually resulted in an award, according to the SSA. And the percentage of awards has declined every year. Among those who did receive benefits in 2017, the average monthly amount paid was about $1,197.
If you’re not sure whether you qualify, you can use the SSA’s Benefit Eligibility Screening Tool to get an idea of your eligibility.
Although SSDI and SSI are government benefits from the SSA, disability insurance is a private-sector source of disability income. It’s a type of insurance that may pay a portion of your salary when you’re disabled. Employers may provide disability insurance and might pay all or part of the premiums for you, but if your employer doesn’t provide the insurance you can purchase your own policy.
Here are two main types of disability insurance.
- Short-term disability insurance, which may replace part of your income for up to two years, although most last for a few months to a year.
- Long-term disability insurance, which, after a waiting period, may pay disability benefits for a few years or until your disability ends.
Different types of disability benefits have different tax requirements under IRS rules.
Taxing Social Security disability income
SSI payments are not taxable.
SSDI benefits, like other Social Security income, must be reported on your tax return. Whether you pay tax on those benefits depends on your total income and benefits for the year.
You may have to pay federal income tax on your SSDI benefits if the total of half of all your SSA benefits, other than SSI, plus all your other income (including tax-exempt interest) is greater than the base amount for your filing status. If you’re married and file a joint return, you have to calculate your total based on all your income and your spouse’s income combined, even if your spouse didn’t receive benefits.
The base amounts are …
- $25,000 for single, head of household or qualifying widow(er)
- $25,000 if you are married filing separately and lived apart from your spouse for the entire year
- $32,000 for married filing jointly
- $0 if you are married filing separately and lived with your spouse at any time during the tax year
Taxing disability insurance
The federal tax rules for private disability insurance payments depend on who paid the premiums and how they were paid.
Generally, if your employer paid the premiums, then the disability income is taxable to you. If you paid the premiums, the taxability depends on whether you paid with pretax or post-tax dollars. A pretax deduction is taken out of your pay before any taxes are withheld, so it reduces your taxable income. Post-tax deductions are taken out after your income and payroll taxes have been withheld.
“When it comes to the IRS, it’s a simple concept: Pay me now or pay me later,” says Michael Menninger, a certified financial planner with Menninger & Associates in Trooper, Pennsylvania. “If an employee pays with after-tax dollars (pay me now) into their disability policy, whether through their employer or into a private policy, then the benefit is tax-free.”
On the other hand, if the premium is paid with pretax dollars, then you receive the tax advantage now, and any disability payments you receive in the future would be taxable income.
Sometimes, the employer and the employee split the premium. In that case, Menninger says, if the employer pays a portion of the premium and the employee pays the remainder with after-tax dollars, then the payout is only partially taxable.
These rules apply only to federal income taxes. Depending on where you live, you may also have to pay state and local income taxes on your disability benefits. It’s a good idea to check with your state and local taxing authorities or your tax professional to learn about the laws in your area.
Whether your disability income comes from the SSA or an insurance policy, you can ask to have federal (and possibly state) income taxes withheld.
For SSDI, you can ask the SSA to withhold taxes when you first apply, or by completing Form W-4V and selecting a withholding rate of 7%, 10%, 12% or 22%. If you receive disability benefits from an insurance company, you can ask the company to withhold federal income tax by filling out Form W-4S.
Having tax withheld from your monthly payment may help you avoid a tax bill come Tax Day. Just remember, though, if you overpay your taxes, filing a return will be the only way to get your overpayments refunded to you, unless you decide to take the overpayment as a credit toward future tax obligations.
When illness or injury prevents you from working, disability income can be the difference between maintaining your standard of living or facing a devastating financial hardship. So it’s a good idea to consider disability income as a part of your overall financial plan.
Menninger advises all his clients to select an after-tax disability insurance policy if one is available through their employer.
After all, he says, your share of the monthly premium might be small and affordable while you are working. “If you’re on disability and are reduced to living on 60% or so of your normal income, then you’ll need every penny you can get.”
Relevant sources: Social Security Administration Benefits Planner | Council for Disability Awareness: Disability Statistics | Social Security Administration: Disability and Death Probability Tables for Insured Workers Born in 1997 | Social Security Administration Red Book | Social Security Administration: Selected Data from Social Security’s Disability Program | USA.gov: Benefits and Insurance for People with Disabilities | National Association of Insurance Commissioners: Simplifying the Complications of Disability Insurance | IRS FAQs: Regular & Disability Benefits | IRS FAQs: Social Security Income | IRS FAQs: Life Insurance & Disability Insurance Proceeds | Social Security Administration: Benefits Planner – Withholding Income Tax from Your Social Security Benefits
A senior product specialist with Credit Karma Tax®, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.