The taxability of long term disability insurance benefits depends on several factors, including whether the policyholder paid the premiums with pre-tax or after-tax dollars, whether the policyholder is receiving benefits from an employer-provided plan, and whether the benefits are subject to offset under the long term disability policy. Fees paid to an attorney to help you file a long term disability claim, appeal a long term disability claim denial, or to litigate against your long term disability insurer are generally considered tax deductible.
This article provides some general information regarding typical disability benefit scenarios, but The Maddox Firm cannot provide any specific tax or accounting advice. We encourage you to speak with a tax attorney or accountant for specific information regarding the taxability of your long term disability benefits and legal fees.
What are the Tax Implications of Receiving Long Term Disability Insurance Benefits?
The taxability of long term disability benefits turns on how the premiums were paid. If the policyholder paid the premiums with after-tax dollars, the benefits received from the insurance company are generally not taxable. If the policyholder paid the premiums with pre-tax dollars, the benefits received from the insurance company are generally taxable.
If long term disability insurance benefits are taxable, the policyholder will be required to pay income taxes on the benefits received. The amount of tax owed will depend on the policyholder's tax bracket and the amount of benefits received. Additionally, the policyholder may be required to pay taxes on any interest earned on the benefits received.
Below are some scenarios exploring the differences between pre-tax dollar premium payments and after-tax dollar premium payments.
Individually Purchased Long Term Disability Policies: If the policyholder bought the long term disability insurance policy on their own or through a broker, the premiums were very likely paid with after-tax dollars. Generally, in this scenario, because premiums were paid with after-tax dollars, the benefits received from the insurance company will not be taxable.
Employer-Paid Long Term Disability Policies: If the policyholder is receiving benefits from an employer-provided plan, the taxability of the benefits depends on whether the employer or the employee paid the premiums. If the employer paid the premiums, the benefits received are generally taxable as income. If the employee paid the premiums, the benefits received may or may not be taxable, depending upon how the premiums were deducted.
Pre-Tax Paycheck Premium Deduction: If the policyholder paid the premiums with pre-tax dollars, such as through a payroll deduction or a flexible spending account, the benefits received will generally be taxable. This is because the premiums were paid with pre-tax dollars, meaning that the policyholder did not pay taxes on the income used to purchase the policy.
Post-Tax Paycheck Premium Deduction: If the premiums were deducted from the policyholder’s paycheck after taxes were deducted from salary, the premiums were paid with after-tax dollars. Generally, in this scenario, because premiums were paid with after-tax dollars, the benefits received from the insurance company will not be taxable.
Hybrid Scenarios: Many policyholders find themselves in a hybrid scenario – one which combines two or more of the above scenarios. The most common example of a hybrid scenario is where the employer pays for a portion of the premium and the policyholder pays for the remainder of the premium. If the policyholder pays for their portion of premium with after-tax dollars, a portion of the benefit will be taxed, and a portion of the benefit will not be taxed. The proportion of pre-tax dollars to after-tax dollars paid for the premium will be equal to the proportion of the benefit that is taxable.
How Do Offsets Affect the Taxability of Long Term Disability Insurance Benefits?
In general, if long term disability benefits are subject to offset, then long term disability benefits are reduced by the amount of the offset. The amount of tax due on account of receiving long term disability benefits will also be reduced. Typical offsets include Social Security Disability (SSD) Benefits, Workers’ Compensation Benefits, and other disability income. Some of these benefits are taxed, and some of these offsets are not taxed.
Social Security Disability Benefits are generally taxable. That means, for example, that if an individual is receiving $2,000 per month in long term disability benefits and $1,000 per month in SSD benefits, then the offset would reduce the long term disability benefits to $1,000 per month. If the individual paid the premiums for their long term disability policy with post-tax dollars, then the $1,000 of long term disability benefits will remain untaxable. The $1,000 of SSD benefits will be taxable. That means that the taxable portion of the total amount of disability benefits will be 50%.
What Are Some Tips for Minimizing the Tax Impact of Long Term Disability Insurance Benefits?
If you receive long term disability insurance benefits, there are several tips you can follow to minimize the tax impact of these benefits:
Pay premiums with after-tax dollars: If possible, pay your long term disability insurance premiums with after-tax dollars to ensure that any benefits received are not taxable.
Consider a lump-sum payment: If you are receiving long term disability insurance benefits in a lump-sum payment, you may be able to minimize the tax impact by negotiating a settlement that spreads out the payments over time. Check our disability buyout calculator to determine whether the long term disability insurance company’s offer is fair.
Work with a tax professional: If you are unsure about the tax implications of your long term disability insurance benefits, work with a tax professional such as a tax attorney or accountant to ensure that you are taking advantage of all available tax deductions and exclusions.
Are Legal Fees for Long Term Disability Attorneys Taxable?
Usually, legal fees for long term disability attorneys are not taxable. This is because legal fees for long term disability attorneys are an “above-the-line” deduction on your taxes. Above-the-line deductions are those that are deducted from your gross income to calculate your adjusted gross income. Above-the-line deductions are available to you whether or not you choose to itemize your deductions when tax time comes. Above-the-line deductions cannot exceed your gross income.
Although most legal fees for other personal legal services are no longer tax deductible, legal fees for long term disability legal services are subject to a special IRS rule. Section 62 of the tax code explains what is or is not included in “adjusted gross income.” Adjusted gross income is income after deductions, including a deduction named “Costs involving discrimination suits, etc.” This deduction includes attorney fees for “claims for wages, compensation, or benefits.” Attorney fees for long term disability insurance benefits are included in this “above-the-line” deduction.
How The Maddox Firm Can Help
Long term disability insurance benefits can be a valuable source of income for individuals who become disabled and are unable to work. However, the tax implications of receiving these benefits can be complex and confusing. In general, if the long term disability insurance premiums were paid with after-tax dollars, the benefits received will not be taxable. If the premiums were paid with pre-tax dollars, the benefits received may be taxable.
If you are receiving long term disability benefits, it is important to understand how your taxes will be affected by your receipt of those benefits. It is also wise to consult with an experienced long term disability attorney who can help you navigate these complex issues with your disability insurer and ensure that your rights are adequately protected throughout the long term disability process.
We always recommend speaking with a trusted attorney if you have any questions about your short term or long term disability insurance claim. Whether you are looking for assistance in navigating the claims process, maintaining your long term disability benefits, appealing a claim denial, or litigating a final adverse decision, The Maddox Firm can help. The team at The Maddox Firm will look over your insurance policy, correspondence from your insurance company, medical records, and any other relevant documentation in order to give you personalized guidance on how we can help you win your short and/or long term disability claim.
Contact us to help you file your claim, appeal, or litigation the right way.