The taxation of disability insurance benefits can differ, based on who pays the premium, and whether the money used for the premium payment has already been taxed. For example, with individual disability insurance, you will usually pay the premium with after-tax dollars. Therefore, the benefits will be tax-free.
Unlike health and long-term care insurance premiums, though, you may not deduct the premium that you pay on your tax return as a medical expense.
If you have a disability insurance plan through your employer, the taxability will depend on whether you or your employer pays the premium. If you pay the full amount of the premium with after-tax funds, then the benefits will be tax-free.
However, if your employer pays for the full amount of the premium – and they do not include the cost of the coverage in your gross income – your disability benefits that you receive will be considered taxable.
If you pay part of the premium and your employer pays another part of it, then your tax liability will be split – based on the percentage of premium that you paid. In this case, if you each pay 50% of the premium, then 50% of the benefits received would be taxable.