Question Is the long-term disability I am receiving considered taxable? Answer You must report as income any amount you receive for your disability through an accident or health insurance plan paid for by your employer: Amounts you receive from your employer while you're sick or injured are part of your salary or wages.
- Report the amount you receive on the line "Wages, salaries, tips, etc." on Form 1040, U.S. Individual Income Tax Return or Form 1040-SR, U.S. Tax Return for Seniors.
- You must include in your income sick pay from any of the following:
- A welfare fund
- A state sickness or disability fund
- An association of employers or employees
- An insurance company, if your employer paid for the plan
You can generally exclude from income payments you receive from qualified long-term care insurance contracts as reimbursement of medical expenses received for personal injury or sickness under an accident and health insurance contract. Also, you can exclude from income certain payments received under a life insurance contract on the life of a terminally or chronically ill individual (accelerated death benefits). Refer to Publication 907, Tax Highlights for Persons with Disabilities.
You may be able to deduct your out-of-pocket expenses for medical care above any reimbursements, if you're eligible to itemize your deductions. You'll need to review Publication 502, Medical and Dental Expenses and Can I Deduct My Medical and Dental Expenses?
For more information, refer to Publication 907.
Disability insurance is an insurance policy that gives income to individuals who can’t work because of disability. The purpose of disability insurance, therefore, is to protect people from financial losses if an accident or illness makes them unable to work and receive regular income. If you are considering disability insurance for a business, it is wise to know the potential tax implications.
How are S Corporations Taxed with Disability Insurance?
The good news is that individual disability income insurance premiums can be deducted by an S Corporation. This is because shareholders with more than 2% of the shares are treated as self-employed for accident and health benefit purposes, and the premiums are included in the shareholder's taxable income, which makes tax-free benefits.
Is this also the case for other business entities?
Disability insurance can also be paid and deducted by a C corporation, however, if premiums paid by a C corporation are excluded from the shareholder employee’s W-2 income (for example, accident and health insurance premiums) then the benefits paid under the policy will be taxable. The only way to make a non-taxable benefit is if those premiums paid are instead included in the shareholder/employee’s W-2 income.
Individual disability insurance premiums paid by a Sole Proprietor are not tax deductible, but benefits received are tax-free.What about Partnerships? For disability insurance purposes, partners are considered self-employed individuals rather than employees. As such, they are included in the insured partner’s income, which makes benefits paid under the policy tax-free.
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How are S Corporations Taxed with Life Insurance?
If an employee is the beneficiary, S corporations are allowed to deduct life insurance premiums. In the event that the employee dies, the S corporation can’t get compensation or payment from the life insurance plan. In short, employee life insurance premiums paid by the S Corp are tax deductible for the business. The money received from surrendering a policy is exempt from taxes up to the amount of premiums paid into it.
How Does Business Overhead Expense (BOE) Disability Insurance Work?
Premiums that are paid for a BOE are a business expense and deductible no matter how the business is organized. If the BOE policy is owned by the business, then the benefit flows through the business. While the BOE benefit is taxable income for the business, the overhead expenses will usually offset the benefits paid to eliminate a possible taxable gain.
How Does a Disability Buy-Sell Policy Work?
Buy-Sell coverage protects an interest in a business and is akin to a personal insurance purchase. Buy-Sell premiums aren’t tax-deductible and benefits are paid tax-free. Thus, when a disabled owner’s interest is bought, he or she will generally have a capital gain on the difference between his or her basis in the business and the purchase price.