Is disability income taxable? SSDI, SSI, VA, workers' comp and private plans

Disability money is taxed by where it comes from, not by the fact that you are disabled. Two of the five common sources are never taxable, and one depends entirely on who paid the premiums.

The five sources, in one line each

Social Security disability insurance runs through the same formula as retirement benefits, so part of it, all of it or none of it may be taxable. Supplemental Security Income is not a Social Security benefit for this purpose and is never taxable; those payments stay out of income altogether. Disability compensation from the Department of Veterans Affairs is not included in gross income. Workers' compensation is not taxable when it is paid for an occupational sickness or injury under a workers' compensation act or a similar law. A private or employer long-term disability policy depends on who paid the premiums.

Two of those need one sentence each. The rest of the article takes the ones with conditions attached.

Social Security disability insurance

The calculation adds half your benefits to the rest of your income and compares the total with a base amount fixed by your filing status; above a second, higher threshold as much as eighty-five percent of the benefit can end up taxable. Whether you owe anything therefore turns on the other income in the household rather than on the benefit itself.

Is Social Security taxable? carries the worksheet and works the arithmetic through, so this article does not repeat it. One case does belong here, because it catches people at the worst moment: if you are married filing separately and you lived with your spouse at any time during the year, the base amount is zero, and the formula bites from the first dollar of other income.

Veterans Affairs benefits are not income

Veterans over-report this one more than any other. Benefits paid under laws the VA administers stay out of income: disability compensation and pension payments for disabilities paid to veterans or their families, education and training allowances, grants for an adapted home or vehicle, veterans' insurance proceeds and dividends, and other VA benefits of the same kind. The VA describes disability compensation on its own site as a monthly tax-free payment, and the tax rules agree with that description.

There is one case to ask about rather than assume. A military retiree whose disability payments do not come from the VA is on different ground; Publication 525 covers that situation, and it is worth putting in front of a preparer before a return goes out.

Workers' compensation

Amounts paid under a workers' compensation act or a similar law for an occupational sickness or injury are not taxable. The payments that tend to arrive alongside are treated the same way, which saves reporting them by mistake: compensatory, though not punitive, damages for physical injury or physical sickness; disability benefits under a no-fault car insurance policy for lost income or earning capacity after an injury; money paid because an injury cost you a body part permanently, or the use of one, or left you disfigured; and payments from a public welfare fund, such as those made because of blindness.

The private policy: who paid the premiums decides

If your employer paid for the plan, the benefits you receive are taxable, and that covers sick pay from an insurance company your employer paid, a welfare fund, a state sickness or disability fund, or an association of employers or employees. If you paid the premiums on the accident or health policy yourself, the benefits are not taxable.

A cafeteria plan sits between those two, and the answer follows the money. If the premiums went through the plan and were not included in your income, you are not treated as having paid them, so the benefits are taxable. If the premium amount was included in your income, you are treated as having paid them, and the benefits are not taxable. Your pay stub and your W-2 are where that question gets settled.

Retiring on disability, before and after minimum retirement age

A disability pension under a plan paid for by your employer has to be included in income, and where it is reported changes with your age. Until you reach minimum retirement age the taxable payments are reported as wages. Beginning on the day after you reach it, the same payments are taxable as a pension or annuity. Minimum retirement age is generally the age at which you could first have received a pension or annuity had you not been disabled.

That switch matters more than it sounds. The line the money lands on changes, and so does the form the payer sends, so a return that looks wrong against last year's may simply be a year in which you crossed that line.

Lump-sum back pay, and withholding

A retroactive payment of benefits received this year goes into this year's income, even when it covers an earlier year. There is an election that can soften it: you may be able to figure the taxable part of the earlier year's portion using that earlier year's income, if doing so lowers your taxable benefits. It is a checkbox on the return rather than a separate form, and it is worth asking a preparer whether it helps in your case.

If disability income has left you owing at filing time, you can ask Social Security to withhold federal income tax from benefits, and a pension or annuity payer can withhold on request too. The Social Security page for that request is in the sources below.