Dear Tax Talk,
I've been on short-term disability for three weeks, and I was curious if the money I received is taxable? I get 65 percent of my pay and my employer pays the premium, but it's part of my current earnings. I talked with the disability company and they said they would be issuing a W-2. Does this mean it's taxable? If this is true, I know the IRS matches W-2s with the tax return.
Disability income is taxable when your employer has paid the premiums and the premiums have been excluded from your earnings. As a general rule, an employer generally excludes disability premiums from an employee's earnings. The exclusion is similar to the exclusion for health insurance and group life.
If you pay the disability premiums through a cafeteria plan, and the amount of the premium was not included as wages to you, the premiums are considered paid by your employer, and the disability benefits are fully taxable.
When you say that the premiums have been included as part of your earnings, you must be in some special situation that precludes the employer from excluding the premiums from your wages.
For example, you may have elected to pay the premiums on an after-tax basis to avoid paying tax should you collect under the policy. The insurance provider may not be aware of this special situation and assumes that the premiums have been excluded from your wages. See for example, IRS Revenue Ruling 2004-55. Accordingly, your employer needs to inform the insurer of the special circumstances so that it does not issue a Form W-2.