The taxability of long-term disability benefits depends on who paid the premiums for the insurance policy and whether those premiums were paid on a pre-tax or after-tax basis.
- Employer-Paid Premiums (Pre-Tax Basis):
- If your employer paid the premiums for your long-term disability insurance and did not include the cost of the coverage in your gross income (i.e., the premiums were paid on a pre-tax basis), the benefits you receive are taxable. This is because the premiums were not included in your taxable income when paid by the employer. According to § 105(a) of the Internal Revenue Code, amounts received by an employee through accident or health insurance for personal injuries or sickness must be included in gross income to the extent such amounts are attributable to contributions by the employer which were not includible in the gross income of the employee.
- Employee-Paid Premiums (After-Tax Basis):
- If you paid the premiums for your long-term disability insurance with after-tax dollars, the benefits you receive are not taxable. This is because you have already paid taxes on the money used to pay the premiums. According to § 104(a)(3) of the Internal Revenue Code, gross income does not include amounts received through accident or health insurance for personal injuries or sickness if the premiums were paid by the employee with after-tax dollars.
- Combination of Employer and Employee Contributions:
- If both you and your employer paid the premiums, the taxability of the benefits depends on the portion of the premiums paid by each party. The benefits attributable to the employer's contributions (pre-tax) are taxable, while the benefits attributable to your contributions (after-tax) are not taxable. This is supported by § 1.105-1(c) of the Income Tax Regulations, which states that in the case of amounts received by an employee through an accident or health plan financed partially by the employer and partially by the employee, the benefits are taxable to the extent they are attributable to the employer's contributions.
- Special Cases:
- If you paid the premiums through a cafeteria plan and did not include the amount of the premium as taxable income, the premiums are considered paid by the employer, and the benefits are fully taxable.
- Long-term disability benefits received under a no-fault car insurance policy for loss of income or earning capacity are generally exempt from tax.
- Disability benefits under a workers' compensation law are generally fully exempt from tax.
In summary, the taxability of your long-term disability benefits hinges on the source of the premium payments and whether those payments were made on a pre-tax or after-tax basis. If the premiums were paid by your employer on a pre-tax basis, the benefits are taxable. If you paid the premiums with after-tax dollars, the benefits are not taxable. If both you and your employer contributed, the benefits are taxable to the extent of the employer's contributions.
Sources:
LTR 8838043
Publication 525 (2023)
PLR 200305013
Rev. Rul. 2004-55
§ 105. Amounts received under accident and health plans
PLR 9329009
