Who Pays Taxes on Disability Income? It Depends

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Published January 31, 2012

| Bankrate.com

Dear Tax Talk,

My company currently pays 100% of the premiums for long-term disability insurance, or LTD, short-term disability insurance, or STD, accidental death and dismemberment, etc. We do tax on the premiums for LTD through payroll because if any payments are disbursed, they are not taxed.

However, we are debating whether premiums should be taxed. If those benefits are used, our third party pays the benefits and also withholds deposits and reports the taxes. They issue W-2s, not us. So I don't think the company-paid "premiums" should be taxed also. You wouldn't tax both, right? Can you explain how these taxable fringe benefits work?

Please help. I could also use some definitive documentation on this.

-Julia

Dear Julia,

I'm not sure what you mean by: "We do tax on the premiums for LTD through payroll because if any payments are disbursed, they are not taxed."

However, disability is very simple: If the company pays the premiums and does not include it as income to the employee, the benefits paid under a claim of disability to an employee are taxable to the employee. There is no distinction in taxation between short-term or long-term disability benefits. If the employee reimburses the company for the premiums for at least three years prior to a claim or their length of employment (if shorter), then it is considered employee-paid, and there is no taxation of the benefits.

Workers' compensation benefits are not taxed as they are on account of an accident, which is distinct from disability, which can be based on health issues or nonwork-related accidents. Accidental death and dismemberment benefits are exempt under law as life insurance. Life insurance benefits are always tax-free. Group life insurance up to $50,000 per employee is excludable from an employee's income. Any excess benefit provided is includable in the employee's income based on IRS tables. IRS publication 15-B is an employer's guide to taxation of fringe benefits.

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