When and How Disability Payments Are Taxed
Short-term disability payments can at least partially replace the money you would have earned during that period if you cannot work due to an illness, injury, or even delivery. You can buy your policy, but many employers include this coverage as part of a compensation package.
Insurance includes short-term disability. It shouldn't be mistaken with the Social Security disability benefits offered by the Social Security Administration, a branch of the federal government (SSA).
For a few months to up to two years, short-term disability insurance normally covers a portion of your income.
It typically pays anywhere between 40% and 70% of your earnings. Whether and how much of your short-term disability benefits are taxable depends on how and whether you make premium contributions.
Key Takeaways
- While you cannot work due to an injury or sickness, short-term disability benefits can replace a portion of your income.
- Although you can buy your policy, these benefits are frequently included in a pay package provided by an employer.
- Depending on who pays for the insurance, short-term disability benefits may or may not be taxable. Your benefits can be taxable if your employer covers all or a portion of the premiums.
When Is Short-Term Disability Taxable?
Short-term disability is regarded as a form of sick pay by the IRS. Therefore, it's typically only regarded as taxable income if your employer covered the premiums in whole or part. That amount is also taxable if you used pre-tax funds to pay all or part of your premiums. Your short-term disability would be taxed, for instance, if your employer subtracted your premiums from your income and utilized the remaining amount to determine your tax withholding.
Here's how it breaks down:
- Your short-term disability income is taxable if your employer covers all your premium costs.
- The premiums would be split precisely 50/50 between you and your employer, and if you paid your share of the premiums with after-tax money (as opposed to payroll deductions), half of it would be taxed.
- Your benefits are not taxable if you pay your premiums with after-tax money.
If you obtain short-term disability benefits from a policy for which you directly paid all premiums, such as if you purchased your coverage independent of your employer, these payments are not taxable.
How Is Short-Term Disability Taxed?
Let's imagine that for the tax year 2021, you received $9,000 in short-term disability benefits spread out over six months. Half of the premiums were covered by your company, and the other half was paid through pre-tax withholding from your paychecks. Your Form 1040 tax return must declare the entire $9,000 as taxable income. The W-2 form you got from your employer, which lists all of your taxable income, should include the taxable amount. Along with any additional income, salaries, or tips, you would include this sum on line 1 of your 2021 tax return.
You can ask your insurance provider to deduct taxes from your benefits by submitting IRS Form W-4S, the "Request for Federal Income Tax Withholding From Sick Pay" form. To pay any taxes that will ultimately be required, you can also voluntarily transmit estimated tax payments to the IRS. By doing this, you can avoid having a hefty tax burden when it comes time to file.
Your total annual income from all sources determines how much tax you'll have to pay for your short-term disability benefits. When you sum up your entire income, you'll pay a portion of the benefits corresponding to your highest tax bracket. The tax rates for a single person in 2021 are as follows:
| Total Income |
Tax Bracket |
| Up to $9,950 |
10% |
| $9,951 to $40,525 |
12% |
| $40,526 to $86,375 |
22% |
| $86,376 to $164,925 |
24% |
| $164,926 to $209,425 |
32% |
| $209,426 to $523,599 |
35% |
| $523,600 or more |
37% |
Using the same scenario above, let's say you had a taxable income of $45,000 and made $36,000 in salary and wages in addition to $9,000 in short-term disability payments. Your income would be taxed at 10% on the first $9,950. The portion of your income between $9,951 and $40,525, which includes the majority of your pay and the first $4,525 of your short-term disability benefits, would then be subject to a 12 percent tax.
The remaining $4,475 in benefits would be subject to a 22 percent tax on the percentage of your income that is over $40,525.
Only single and married people who file separate tax returns are subject to these tax brackets. Different tax brackets are a little more lenient for taxpayers who qualify to file as the head of household and married taxpayers who file joint returns.
How States Tax Short-Term Disability Benefits
Unless you reside in one of the nine states without an income tax, taxation doesn't start and stop with the federal government:
- Alaska
- Florida
- Nevada
- North Dakota (taxes only interest and dividend income)
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Short-term disability benefits are not taxed in New Jersey, California, or Rhode Island, although the IRS has some restrictions.
In New Jersey, for instance, the IRS mandates that employers treat short-term disability payments as third-party sick pay. Because of this, even though the benefits are not taxable at the state level, short-term disability is taxable at the federal level under IRS regulations. This includes the employer's portion of FICA taxes (Social Security and Medicare).
In California, payroll deductions from employees' paychecks are needed to fund the state's disability insurance program. However, the IRS only levies taxes on these benefits if the IRS determines that they serve as a replacement for unemployment benefits. In this scenario, your employer must issue you a Form 1099-G to record the income. Your short-term disability benefits are not taxable in any other case.
Consult your employer's human resources department or a local tax expert if you're unsure whether your state's short-term disability is taxed.
