Taxation of disability insurance claims

Dear Tax Talk,
I am self-employed, and in the past, I have deducted the premiums for disability. This year, I did not claim the premiums as a business expense. I will be receiving disability payments. Since I paid the premiums out of my own pocket this year, will the disability payments be taxable?
— John

Dear John,
It sounds like you stumbled on a great strategy, and you may have one excellent loophole.

A disability policy is an annual insurance. If you fail to pay an annual premium, you can’t collect based on prior payments. Therefore, it goes to reason that if you don’t deduct the current premium, you shouldn’t have to pay taxes if you were to collect. In fact, a great strategy would be to always pay the premium personally and prior to renewal; if you’re not disabled, you would seek reimbursement from your company.

While there are rules in place that require three-year averaging of premiums to determine taxation, these probably do not apply to your situation. Based on the limited information you provided, you may very well be able to avoid taxation of the disability payments. However, you should review your situation closely with a CPA to determine the proper taxation of your disability income based on all your facts and circumstances.

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