Taxation of Disability Income Insurance Benefits
Who pays for disability insurance premiums (employer, employee or a combination) and how premiums are paid (pre-tax or after-tax dollars) determine if disability insurance contributions are tax deductible and if benefit payments are taxable or tax-free.
Generally, if your company pays the disability insurance premiums for your employees, you can consider this a tax-deductible business expense. But any benefits paid to an employee will be taxable to the employee, thus reducing the actual benefits received. You can pay part of the premium cost with employees picking up the rest of the cost. In that case, the portion of the benefit that you pay for will be taxable to the employee and the portion paid by the employee, assuming it is paid using after-tax dollars, will be tax-free.
Employees who purchase coverage through your company group plan can choose to pay with pre-tax dollars or after-tax dollars. Just as with a qualified retirement plan, if premiums are paid with pre-tax money, which gives the employee an up-front tax break, then any benefits paid are taxable. If premiums are paid with after-tax dollars, then all benefits received are tax-free.