Pay Taxes on Disability Income? Say it Ain't So

Dear Tax Talk,

I was injured at work. I've been on "light duty" for nine weeks. The company has a policy that employees can only work on light duty for 12 weeks. I have three weeks left before I am taken out of work until surgery and therapy is done and I am in full-working condition.

The insurance company is paying all medical bills due to the injury and will be picking up 66 percent of my wages. Am I still going to be taxed on this? Do I have to report this disability income? The amount I will be receiving will be several hundreds less than what I made while working after I was taxed. If I'm taxed on the 66 percent I'll be getting for disability from a work injury, I'm not sure I'll be able to pay the bills! I'm so confused about all of this.

Best Banks for Savings -- View Today's Rates!

Will I have to pay any taxes at all? During or after? -- Rachel

Dear Rachel, The income you receive for your disability is taxable if it is from an accident or health insurance plan paid for by your employer, as this is considered by the IRS to be salaries and wages.

However, if the health or insurance plan was paid by you, then the taxability of disability income will depend on how you paid the premiums.

If you paid the premiums through a cafeteria plan with pretax dollars, then the income you receive is taxable. If you paid the entire cost yourself, then it is not taxable.

If you determine that this is taxable to you, then the income is going to be reported on Form 1040, line 7 and you may need to make estimated tax payments using Form 1040-ES. Alternatively, you can submit a Form W-4S, Request for Federal Income Tax Withholding From Sick Pay, to the insurance company. This is important, as you do not want to end up with any penalties or interest due to not paying enough taxes.

I wish you a speedy recovery from your surgery and hope you are back on your feet soon. In the future, it is a good idea to set up a savings account, even if you start with very small amounts, that will build up over time to help you get through times such as this.

Thanks for the great question and all the best to you.

Ask the Adviser

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.

Copyright 2014, Bankrate Inc.