The Internal Revenue Service states that all income is taxable unless "specifically excluded by law," and this applies to long-term disability income. The taxability of this income is a complex question because it depends upon the sources of the income, which can include government programs, employer plans, and private insurance policies.
The IRS has a specific publication to assist filers in determining whether their income is taxable for not. Publication 525 explains both taxable and nontaxable income for those with disability income. A Form 1099-LTC is needed to file along with your taxes when receiving long-term care benefits as well.
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Consider Also: Do You Pay Taxes on Disability Payments?
Federal Disability Benefits
The Social Security Administration offers two programs that provide long-term disability income. Supplemental Security Income makes disability payments based upon financial need and is always untaxed. Social Security Disability Insurance (SSDI) pays benefits based on the Social Security taxes you've paid. Social Security benefits that are your sole income source are generally not taxable.
Part of your SSDI benefits may be taxable if you also have other sources of income. The taxable amount depends on your total income and your tax filing status. Similar rules apply to railroad retirement disability benefits. Disability payments from the Department of Veterans Affairs are not taxable.
Also Consider: Who Can Receive Short-Term Disability?
Other Non-Taxable Disability Payments
Many other sources of disability payments are not taxable, including public welfare funds; worker's compensation for occupational sickness or injury; damages awarded to compensate you for physical injury or sickness, excluding any punitive damages; "no-fault" car insurance disability benefits; and compensation for permanent disfiguration or loss of a body part or function.
Accelerated death benefits from a life insurance policy for chronic or terminal illness and payments from long-term care insurance contracts for personal injury or sickness generally are not taxed, either.
Employer Disability Pensions
You must pay taxes on employer-paid disability pension or annuity income you receive when you retire because of disability. You report these payments as wages until you reach the minimum retirement age for the pension plan.
After reaching this age, your payments are treated as a pension income and may be partially tax-free to the extent they reimburse your taxed contributions to the pension or annuity. Disability payments for injuries from a terrorist attack are not taxable.
Disability Insurance Proceeds
Generally, you must pay taxes on long-term disability payments from an employer-paid accident or health insurance plan. If both you and your employer paid premiums, only the payments arising from your employer's premiums are taxable. If you paid all the premiums, exclude the disability payments from your taxable income.
However, if you paid the premiums to an employer's cafeteria plan – a plan where you choose the benefits – and didn't pay taxes on those premiums, the disability payments are taxable.
Pre-Tax or Post-Tax Benefits
Because long-term disability income e is sourced from multiple places, it is important to know whether your source contains pre-tax or post-tax dollars.
As mentioned before about annuities, the funds distributed from the annuity after retirement age, are not taxable up to a certain amount. So if you put $10,000 post-tax dollars into an annuity, you can withdraw that $10,000 with no tax penalty.
However, if your LTD benefits were never taxed, this would be like a group disability fund, you'll owe taxes on every penny.