Is Disability Insurance Tax Deductible? What To Understand

One of the worst things that can happen to you is not having a safety net to cover expenses in case you fall sick or sustain an injury that prevents you from working. One in four people will likely become disabled when they retire, so don’t assume this will certainly not happen to you.

So, the best protection is to get disability insurance.

In case you do get disability insurance, a frequent question you may have is whether it is tax deductible.

The short answer is that disability insurance premiums are usually not tax deductible. But still, in a few special cases, they may be. Find out more in this post.

Understanding Tax Deductibility for Disability Insurance

You can’t escape taxes on your disability insurance. Either you pay now (before a disability happens), or the benefits received are considered taxable income.

Unfortunately, disability insurance policies are designed to cover only a portion of your income if you face a disability. So, paying taxes on disability benefits further reduces the amount, making it insufficient to cover your living expenses when you can’t work. As a result, most people prefer tax-free benefits, so they choose to pay premiums with after-tax dollars.

Bottom Line: If you want tax-free benefits later, don’t get a tax deduction now. If you deduct premiums now, the IRS considers the benefits paid as taxable income.

Are Disability Insurance Premiums Tax Deductible?

Disability insurance premiums aren’t tax-deductible for most people. But if you’re a business owner, you can pay your employees’ group disability insurance premiums with pre-tax dollars. Let’s properly break down when disability insurance premiums are tax-deductible and when they’re not.

Disability Insurance Premiums Are Not Tax Deductible for Private Disability Insurance

Many employees purchase additional disability insurance policies to supplement their employers’ group plans. For example, if your employer offers a group disability plan that covers 60% of your income in case you get disabled, you can purchase private disability insurance to receive more income to cover your expenses adequately.

However, individual disability insurance premiums aren’t tax-deductible. In most cases, you must pay premiums with after-tax dollars. The good thing is that it makes your benefits tax-free.

The only problem is that if you don’t earn enough currently, paying private disability premiums with post-tax dollars will reduce your net salary. So, before you take this step, you want to consult a financial advisor.

Note: Private disability insurance premiums aren’t tax deductible for self-employed physicians either.

Benefits Are Taxable for Employees Under Employer-Covered Disability Insurance

Some companies offer disability insurance as part of their employee benefits package. Employers purchase group disability insurance to protect their employees, but they pay the premium for the disability insurance with pre-tax dollars.

Since some of the insurance premiums come from your salary, it may feel good knowing that your employer can deduct premiums because you would take more money home. However, if you ever need the disability benefits, you must pay tax on the income received.

That means if the benefits paid were 60% of your income, it’s reduced to about 40-50% after taxes, depending on your tax bracket. This is why people purchase additional disability coverage for full income replacement.

What If You’re Self-Employed?

If you have employees and offer group disability insurance, you can deduct the premiums as a business expense. However, as explained earlier, the employee will pay taxes on the benefit payments.

Other than the group plan, self-employed individuals usually purchase disability overhead insurance to cover business expenses like rent, utilities, and employee salaries if they become disabled. In this case, you can also deduct premiums as a business expense. But as the general rule goes, tax-deductible premiums mean taxable benefits.

Is Disability Insurance Tax Deductible for an S Corporation?

In an S corporation (S corp), the owners share the business profits (or losses) among themselves based on how much of the business they own.

The business doesn’t pay taxes for itself. Tax comes from each owner based on their income from the profits. This is to avoid double taxation, unlike C corporation businesses, where the business pays tax and each shareholder pays tax on their personal income as well.

So, are disability insurance premiums tax deductible for an S corp?

In short, the same rules apply to self-employed individuals and S corporation owners. If it’s a group policy, then yes, premiums are tax-deductible. But if it’s an individual plan, you pay premiums with after-tax dollars and enjoy tax-free benefit payments.

Finally, What About Social Security Disability?

Social Security Disability Insurance (SSDI) can be taxable, but only if you have other income that pushes you above certain limits. “Other income” could be your spouse’s salary, rental property, dividends, or tax-exempt interests.

There’s a simple formula the IRS uses to determine taxable SSDI benefits:

Half of your SSDI benefits + all your other income. If this total passes certain thresholds, part of your SSDI may be taxable.

Now, let’s talk about the income thresholds.

Part of your SSDI benefits are taxable if:

• You’re a single filer and your total income is over $25,000.
• You’re married and filing jointly with your spouse with a total income of over $32,000.

If you’re married, filing separately, but living with your spouse at any time during the tax year, your SSDI is always taxable. However, if you didn’t live with your spouse during the year, the income threshold is the same as with single filers ($25,000).

For example, say you are married and filing jointly. Your SSDI benefits = $20,000/year, and your spouse earns $35,000. Let’s do the math.

$10,000 (half your benefit) + $35,000 (other income from your spouse) = $45,000.

Since the total is over the income threshold of married couples filing jointly (>$32,000), part of your SSDI will be considered taxable income.

Next Steps: Consult a Tax Professional

With a solid understanding of tax deductibility and disability insurance, here’s what to do next:

• Review your current disability insurance policy. Check to see if it’s taxable or if you’re missing deductions.
• Book a consultation with Physicians Thrive. Our team of advisors will review your policy again to catch things you may have missed and guide you on the next financially prudent step to insure your future against disability.

Finally, some food for thought. If a disability happens to change your life overnight, will your current choices still make sense? .