How Are Disability Benefits Taxed?

Receipt of disability benefits raises several tax issues. The resolution of such matters concerning disability benefits is often unclear and can sometimes be highly complex. For that reason, this blog is not intended to be an exhaustive discussion of the potential issues. Moreover, the blog provides no more than a general overview of the problems and is not intended to offer tax advice. Readers are strongly encouraged to consult a tax specialist for a definitive opinion on the tax treatment of their benefits and should not rely on any points raised in this article.

Whether your disability benefits are taxable depends on the type of benefit and who paid the premiums. Social Security disability (SSDI) benefits may be partially taxable if your income exceeds certain thresholds. Long-term and short-term disability benefits from employer-sponsored plans are typically taxable if your employer paid the premiums, but tax-free if you paid with after-tax dollars. Individual disability insurance benefits are generally not taxable. This guide explains how each type of disability benefit is taxed in 2026, including recent changes from the One Big Beautiful Bill signed in July 2025.

Takeaways

• Social Security disability (SSDI) benefits may be partially taxable if your total income exceeds $25,000 (single) or $32,000 (married filing jointly).
• Long-term and short-term disability benefits are taxable if your employer paid the premiums; they are tax-free if you paid premiums with after-tax dollars.
• Individual disability insurance benefits are generally not taxable since most insureds pay premiums with after-tax income.
• The 2025 One Big Beautiful Bill did NOT make SSDI tax-free, but it added a new senior deduction for those 65 and older depending on their income.
• Lump-sum settlements follow the same tax rules as monthly payments.

2025 Tax Law Changes Affecting Disability Benefits

The so-called One Big Beautiful Bill (OBBB), signed into law on July 4, 2025, made several changes to the federal tax code. However, it did not eliminate taxes on Social Security disability benefits, despite some public misconceptions. Here is what disability benefit recipients need to know:

• SSDI remains taxable: The taxation thresholds for Social Security disability insurance benefits remain unchanged at $25,000 for single filers and $32,000 for married couples filing jointly.
• New senior deduction: If you are 65 or older, you may qualify for a temporary “senior deduction” of $6,000 (single) or $12,000 (married filing jointly) through 2028. The availability of this deduction is based on all taxable income, not just disability benefits, and could reduce or eliminate your tax liability on SSDI.
• Phase-out limits: The senior deduction begins to phase out at $75,000 AGI for individuals and $150,000 for couples, and is fully eliminated at $175,000 and $250,000 respectively.
• Standard deduction increased: For 2025, the standard deduction is $15,750 for individuals and $31,500 for married couples filing jointly. If your taxable income falls below these thresholds after deductions, you may owe no federal tax.

Are Disability Benefits Taxable?

The taxability of disability benefits depends on their source and how premiums are paid. For example, Social Security disability benefits are taxable if the recipient (and spouse if the benefit recipient files taxes jointly) have earnings in addition to Social Security payments. For individuals with more than $34,000 in income, 85% of benefit payments are taxable. For joint filers, combined earnings over $44,000 are subject to 85% of the benefit to taxes.

Social Security Disability Insurance (SSDI)

SSDI benefits may be partially taxable depending on your total “combined income” (adjusted gross income + nontaxable interest + half of your SSDI benefits). The IRS uses these thresholds:

• Single filers: If combined income is between $25,000 and $34,000, up to 50% of benefits may be taxable. Above $34,000, up to 85% may be taxable.
• Married filing jointly: If combined income is between $32,000 and $44,000, up to 50% of benefits may be taxable. Above $44,000, up to 85% may be taxable.

Related article: How Does Long Term Disability Differ From Social Security? 

Long-Term Disability (LTD) Insurance

The taxability of LTD benefits depends entirely on who paid the premiums and how they were paid:

• Employer-paid premiums: Benefits are 100% taxable as ordinary income.
• Employee-paid with after-tax dollars: Benefits are 100% non-taxable.
• Shared premiums: Benefits are taxable in proportion to the employer’s contribution (e.g., if employer paid 60%, then 60% of benefits are taxable).
• Pre-tax payroll deduction (cafeteria plan): Treated as employer-paid; benefits are fully taxable.

 “Gross Up” Plans

Some employers offer a “gross up” arrangement where employees pay 100% of the LTD premiums on a post-tax basis, and the employer provides a corresponding raise to offset the premium cost. This structure allows employees to enjoy non-taxable disability benefits at essentially no additional cost. If you are evaluating employer disability coverage, ask your HR department whether a gross up plan is available.

Short-Term Disability (STD) Insurance

Insured STD benefits follow the same rules as LTD: taxable if employer-paid, tax-free if you paid premiums with after-tax dollars. Most employer-sponsored STD plans are either self-funded and taxable or the employer has paid the premiums.

Individual Disability Insurance

Individual disability income insurance payments are generally not taxable so long as the individual receiving such payments paid the premiums with after-tax dollars or, for self-employed individuals, did not take a tax deduction for the premiums.

Group benefits are usually taxable, however, in accordance with the amount of the premiums for the insurance coverage that the employer pays. A FAQ  issued by the Internal Revenue Service explains:

• If both you and your employer have paid the premiums for the plan, only the amount you receive for your disability due to your employer’s payments is reported as income.
• If you pay the entire cost of a health or accident insurance plan, don’t include any amounts you receive for your disability as income on your tax return.
• Suppose you pay the premiums of a health or accident insurance plan through a cafeteria plan, and you didn’t include the premium amount as taxable income to you. In that case, the premiums are considered paid by your employer, and the disability benefits are fully taxable.

One problematic issue is whether claimants who must reimburse their long-term disability insurance company for overpaid benefits after receipt of Social Security disability benefits should receive a credit for the taxes owed on the Social Security benefits. Disability insurers will only credit attorney fee payments incurred to collect Social Security and usually not credit taxes. To date, litigation on this issue has been unsuccessful.

Related article: Court Looks at Calculating Credit and Taxes in Disability Benefits Case

If I Had to Hire an Attorney to Collect Taxable Disability Insurance Benefits, Can I Deduct Attorneys’ Fees?

If benefits are taxable, attorney fees incurred in collecting benefits through the claim process or in ligation would likely be deductible.  But this is a question on which many tax professionals disagree due to the Tax Cuts and Jobs Act of 2017, which limited the deductibility of attorneys’ fees for non-business-related litigation. However, according to provisions contained in Section 62 of the Internal Revenue Code, which was not impacted by the 2017 law (and was extended by the 2025 One Big Beautiful Bill), costs and attorneys’ fees incurred concerning claims for unlawful discrimination are excluded from the taxpayer’s gross income. The statute defines unlawful discrimination to include claims involving wages, compensation, or benefits. Thus, only the net proceeds paid to the claimant should be subject to taxation.

Are Lump Sum Settlements of Disability Benefits Subject to Taxes?

The taxability of a lump sum payment of disability benefits is the same as the taxability of monthly payments. Thus, if monthly payments are non-taxable, a lump sum settlement should be as well. However, one potentially problematic issue is if the insurance company requests confidentiality as to the settlement terms. While the payment itself may not be taxable, any portion of the payment to secure the confidentiality of the settlement payment may be viewed as taxable income. The problem may be addressable with careful drafting of a settlement agreement.

If Part or All of an Overpayment Is Forgiven in a Settlement, Is the Amount That Is Forgiven Taxable?

In court cases involving long-term disability benefit payments that have been terminated after being paid for some time, the insurance company may assert a counterclaim alleging that the claimant has been overpaid. When such cases are settled, there is usually a mutual release that forgives the overpayment. The forgiveness of debt potentially creates tax liability; however, the tax obligation can generally be avoided with appropriate language inserted into the settlement agreement.

If My Disability Benefits Are Taxable and I Receive a Settlement of My Claim, Is There an Advantage to Receipt of a Structured Settlement?

Structured settlements are a popular way to resolve personal injury claims to preserve the settlement funds and avoid imprudent expenditures. However, personal injury payments differ from disability insurance benefits since damages received on bodily injuries are not included in gross income taxed by the IRS. That results in far greater flexibility in setting up a structured settlement than would be the case with a taxable lump sum settlement of disability benefits. Even if the lump sum is invested in an annuity that pays out only a percentage of the total each year, the disability benefit recipient would likely be deemed to have constructive receipt of the entire sum used to purchase the annuity.

There may be means of avoiding constructive receipt by utilizing an offshore insurance company and making that entity the owner of the annuity and the claimant the beneficiary of each payment as it is issued. However, that type of arrangement raises a risk that the “owner” of the annuity may become insolvent. If that occurs, any remaining payments would be lost since there is no protection as would exist if a domestic insurance company failed.

Get in Touch if We can Help With Your Disability Insurance Claim Legal Questions

Do I Have to Pay State Taxes on Disability Benefits?

State taxation of disability benefits varies significantly. Most states follow federal guidelines, meaning if your benefits are taxable federally, they are likely taxable at the state level as well. However, some states do not tax Social Security benefits at all, including Illinois. Additionally, a handful of states have no state income tax, including Florida, Texas, Washington, and Nevada. If you receive disability benefits and live in a state with income tax, consult a tax professional familiar with your state’s specific rules.

Common Questions About Disability Benefits and Taxes

Are Social Security disability benefits tax-free?

No. SSDI benefits may be partially taxable depending on your total income. If your combined income exceeds $25,000 (single) or $32,000 (married filing jointly), a portion of your benefits may be subject to federal income tax. The 2025 One Big Beautiful Bill did not change this.

How do I know if my employer paid my disability insurance premiums?

Check your pay stubs for premium deductions. If you see a deduction for disability insurance, note whether it is pre-tax or post-tax. You can also contact your HR department or benefits administrator. If you cannot find premium deductions on your pay stubs, your employer likely paid 100% of the premiums, making your benefits fully taxable.

Are VA disability benefits taxable?

No. Disability compensation from the Department of Veterans Affairs is exempt from federal income tax. You do not need to report VA disability payments on your tax return.

Can I have taxes withheld from my disability payments?

Yes. If your disability benefits are taxable, you can request federal income tax withholding. For SSDI, submit Form W-4V to the Social Security Administration. For employer-sponsored disability, your insurer or employer can typically withhold taxes from your benefit payments. Alternatively, you can make quarterly estimated tax payments using Form 1040-ES.

Concluding Thoughts

Taxes are complicated, and even savvy people with significant business experience can make serious tax mistakes without the assistance of a tax professional. The insurance companies that pay disability benefits make no representations about tax liability, nor do they take responsibility for tax issues that arise. Further, tax law is an entirely different field despite an attorney’s experience and expertise in dealing with disability benefits issues. The attorney may not be willing or able to provide tax advice.

Before disability occurs, though, to the extent someone who has disability insurance has the option through their employer or their business entity of setting up their disability program on a taxable or non-taxable basis, it would be preferable to elect benefits that are not subject to taxation. Making such an election may impact settlement negotiations in litigation if a dispute arises over payment of benefits.

Understanding how your disability benefits are taxed can help you make better decisions about your coverage and avoid surprises at tax time. The key factors are:

1. the type of benefit (SSDI, LTD, STD, or individual),
2. who paid the premiums, and
3. whether premiums were paid with pre-tax or after-tax dollars.

While DeBofsky Law does not provide tax advice, our attorneys understand how tax considerations may affect disability benefit claims, settlements, and disputes. If you are facing a denied disability claim or need help navigating the appeals process, the tax treatment of any potential recovery is one of many factors we can help you evaluate. Contact us for a consultation to discuss your disability benefits situation.