Long term disability (LTD) benefits can provide a vital economic lifeline for those who have an illness or injury that prevents them from working. Our long term disability claims attorneys can explain the importance of reading and understanding the specific terms of any insurance policy entered into, but most LTD policies replace a certain percentage of pre-disability income for a set period of time. For example, common monthly benefits are 66 percent of previous income payable until the claimant’s normal retirement age as determined by the Social Security Administration (SSA). Whether the LTD benefits are taxable or not will have a significant impact on the individual’s quality of life.
Funding the LTD Plan
The primary factor in determining the taxability of LTD benefits is to look at which party pays the insurance policy premiums. For employer plans, there are three options: the employer can pay 100 percent of the premiums, the employer can deduct 100 percent of the premium from the employee’s wages through withholding or the employer can withhold some amount less than 100 percent, in which case a pro-rated amount for each of the respective contributions can be determined. This may be a 70/30 employer/employee split or 40/60 or 50/50.
In any of these scenarios, the employer’s contributions are not included in the employee’s gross income. Consequently, the premium payments are not included on the employee’s W-2 statement for the year and are paid with pre-tax dollars. When contributions are paid with pre-tax dollars, then the benefits received will be taxable. Conversely, when premiums are paid with after-tax dollars, the benefits received will be tax free.
Unless otherwise provided, gross income includes compensation for fringe benefits. Thus, if the employer’s payment of premiums for LTD insurance results in an award of monthly benefits to an employee who becomes disabled, those monthly benefits are considered gross income and subject to income tax.
LTD benefits, however, payable through a policy whose premiums were paid solely by the employee (on an after tax basis) are 100 percent tax free. If both employer and employee jointly contribute the pro-rated share of premium payments are used to calculate what percent of the LTD benefits are taxable. For instance, if the employer paid 50% of the premium cost, then the benefits under the Policy are 50% taxable.