The biggest factor that determines if disability income is taxable depends on who paid the disability income. If the income was paid to you directly by your employer, then it is taxable to you just as a normal salary would be. Benefits that are taxable are also subject to federal income tax withholding, although, depending on the disability plan, those benefits are not necessarily subject to Social Security tax.
More often than not, disability payments are not made by an employer, but by an insurer under a policy providing disability coverage or under the arrangement having the effect of accident or health insurance. In cases like these, the deciding factor of whether or not the disability income is taxable depends on who paid for the coverage. If you paid for the policy, then the payments you receive under it are not taxable. But if your employer paid for the coverage, the income is taxed to you as if it was paid directly to you by the employer. If the policy is made available to you at work by a policy arranged by your employer, then the benefits are not taxed to you if you paid the premiums. On the other hand, if your employer paid the premiums but those premiums are included in your taxable income from work, then the premiums are treated as paid by you.
In the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement, there are special rules that apply that will change the determination as to whether or not the disability income is taxable. These rules or circumstances don’t cover the tax treatment of Social Security benefits which are taxed under different rules. If you are interested in learning more about the tax treatment of disability or Social Security benefits, our firm can help you explore the tax consequences and determine the best step for you to take in order to keep yourself financially secure.