When my clients ask me whether or not disability benefits are taxable, my answer is simple – if the premiums are paid with after tax dollars, the benefits are NOT taxable. If the premiums are paid with pre-tax dollars, the benefits are taxable.
Most individuals purchasing disability insurance don’t have a choice, as for an individual, the premiums are always paid with after-tax dollars. A corporation purchasing disability for employees can deduct the premiums, so the benefits paid to the employees are taxable.
This information should be used as a general guide. You should always consult with your accountant to determine the tax consequences as outlined above.