Tax Treatment of Disability Premiums

• If you personally paid your own disability insurance, the tax liability you owe on the benefits only occurs if you tax deducted the premium or paid for the disability premiums with pretax dollars, such as funds in a tax-free cafeteria plan. While you might consider the use of funds in a pretax cafeteria plan as your own personal payment, the IRS has a different take on the situation. As long as the amount wasn't included as taxable income to you, it's a tax-free benefit. You pay one way or another, and in this case, you pay on the larger amount -- the disability benefit.
  
  

Military and Government Disability

• If your injury occurred because of working for specific government services on or before September 24, 1975, you don't have to include the disability payments on your taxes. These services include the armed forces in any country, the Foreign Service, the National Oceanic and Atmospheric Administration and the Public Health Service. Military personnel can exclude disability payments if the disability was a result of an armed conflict, took place during extra-hazardous service, was caused by acts of war or training maneuvers or they could receive a disability from the Department of Veterans Affairs if they applied.
  
  

Social Security and Railroad Retirement Disability

• For people whose only income is Social Security disability payments or railroad retirement, you probably won't have any taxation. The disability payments are only partially taxable if half of that annual payment plus other income, including tax-exempt interest is $25,000 and you're single or head of the household. For married individuals, the threshold increases to $32,000. At that point, you'll pay taxes on 50 percent of your disability. If after adding half your Social Security and income together you find you earn $34,000 as a single or head of the household or $44,000 married filing jointly, you'll owe taxes on 85 percent of your Social Security disability.
  
  

Partial Taxation

• Since benefits from premiums paid by you are not taxable, if your employer paid part of the premium, only that percentage of the benefit is taxable. Even if your employer paid the premium but included the amount he paid on your W-2 as taxable income, it's as though you paid it because you paid taxes on the money.