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I receive disability insurance payments. Are they taxable?

Federal income taxation of disability insurance benefits depends on what type of benefits you receive, whether the premiums were paid with pretax or after-tax dollars, and who paid the premiums (you or your employer).

The disability proceeds are taxable to you if your employer paid all of the disability premiums for you and did not include the amount in your gross income, or if your employer paid you directly while you were disabled. If you paid all of the premiums with after-tax income, or if your employer made the contributions and included the amounts in your gross income, any disability insurance benefits paid to you are exempt from tax.

If your employer pays part of each premium and you pay the balance with after-tax dollars, you won't owe income tax on any disability benefit that can be attributed to your portion of the premium. However, you will owe taxes on the portion that can be attributed to your employer's contribution.

For example, Mike contributes $30 per month (after tax) to a disability plan. His employer also contributes $30 per month to the same plan. Mike becomes disabled. Under the terms of the disability insurance contract, Mike receives $3,000 per month for each month he is disabled. Since Mike's employer paid 50 percent of the disability premiums, 50 percent of the benefits will be subject to tax, and $1,500 per month will be subject to income tax.

Different rules may apply if you receive disability benefits through a government disability program, such as Social Security, Veterans Administration, or the military. In addition, different rules apply to workers' compensation. For more information, consult a tax professional.