The Answer Is: It Depends
Whether your disability benefit payments are taxable depends on what type of policy or plan you have and how your premiums are paid. This post is not intended as tax advice—we’ve outlined some basic information below only. You should always speak with a tax professional regarding your particular situation.
Individual Policies: These are policies that you purchase yourself. Generally speaking, if you pay the premiums with after-tax dollars, the benefits you receive are tax free. However, if you pay with pre-tax dollars or deduct your premiums as a business expense, then your benefits will likely be subject to federal income taxation.
Group Policies: Group policies are those offered through associations such as the ADA or AMA. These types of policies offer special terms, conditions, and rates to members and function much like individual policies, with similar tax consequences. Generally speaking, if you pay the premiums (with after-tax dollars) then the benefits you receive are tax free.
Employer-Sponsored Policies: These types of policies can be less straightforward when it comes to taxes, as the payment of premiums can be structured several ways. According to the IRS website:
- If your employer pays the premium and does not include the cost of the premiums in your gross income, then benefits you receive will generally be fully taxable.
- If the employer only offers a policy, but you pay the entire premium without taking a tax deduction, then the benefits you receive will generally be tax-free.
- If both your employer and you pay the premiums then the tax liability will generally be split.
If you are unsure what type of policy or plan you have, and you think your employer might be paying the premiums, you can look at your application (there is typically a portion that states who is responsible for the premiums) or talk to your HR department. For more information, talk to your accountant. You can also go to to the IRS website on disability insurance proceeds to find additional information.
It may be tempting to save money by enrolling only in a plan solely paid for by your employer, paying premiums with pre-tax dollars, or deducting premiums as business expenses. But keep in mind that, if you do become disabled, the amount of your benefits actually available to you will substantially decrease if you are required to pay income tax on them.
Selecting a policy is an important decision, and how benefits will be taxed is a significant factor to consider. With statistics showing that one in four dentists will be disabled long enough to collect benefits at some point in their careers, choosing to save now could hurt you financially down the road.