Understanding the tax implications of short-term disability benefits is crucial for both employees and employers. These benefits provide financial support during temporary incapacity, but their taxation depends on various factors that affect net income.
This article explores how different funding structures influence the taxability of these benefits, as well as state-specific programs and reporting obligations.
Employer-Funded Plans
For employer-funded short-term disability plans, taxation depends on who pays the premiums. If the employer covers the entire cost, the benefits received by the employee are taxable. 1Internal Revenue Service. Publication 525: Taxable and Nontaxable Income
Benefits from employer-paid premiums are subject to federal income tax and may also be subject to Social Security and Medicare taxes, with specific exceptions (for example, payments made more than six months after the last month worked). Employers must follow the IRS sick pay rules for withholding and reporting. 2Internal Revenue Service. Publication 15-A: Employer’s Supplemental Tax Guide (2025)
Employee-Funded Plans
When employees pay for their own short-term disability insurance with after-tax dollars, the benefits received are typically not taxable. 3Legal Information Institute. 26 CFR § 1.104-1: Compensation for Injuries or Sickness
If employees fully fund their disability insurance without pre-tax contributions or employer reimbursements, the benefits are generally tax-exempt. Employees should review current IRS guidance on taxable and nontaxable income for details.
Mixed Contributions
When both employers and employees contribute to insurance premiums, the tax treatment becomes more complex. The taxable portion of benefits generally corresponds to the percentage of the premium paid by the employer, while the portion funded by employees with after-tax dollars remains tax-free.
For example, if an employer covers 60% of the premium and the employee contributes 40%, then 60% of the benefits received would be taxable. Employers should accurately track contributions to report the taxable amount on the employee’s W-2 form. Understanding these rules helps avoid tax issues.
State-Based Disability Programs
State-based disability programs can affect the taxation of short-term disability benefits because programs vary in funding and treatment. Some states fund programs through payroll contributions, and tax treatment can differ between federal and state levels.
For instance, in California’s State Disability Insurance (SDI) program, DI benefits are generally not reportable for federal tax purposes unless they substitute for unemployment benefits, in which case they are reportable and shown on Form 1099-G. 4California Employment Development Department. Form 1099G FAQs
Calculating Taxable Amounts
Determining the taxable portion of short-term disability benefits requires careful calculations, particularly for employer-funded and mixed contribution plans. For employer-funded plans, the entire benefit amount is generally taxable. In mixed contribution plans, the taxable portion corresponds to the employer’s contribution percentage.
For example, if an employee receives $5,000 in benefits and the employer funded 70% of the premium, $3,500 of the benefit would be taxable. Accurate documentation of employer and employee contributions is critical to avoid discrepancies during tax filing.
For state-based programs, taxable amounts differ based on state-specific rules. Employees should consult state tax authorities or a tax professional to determine the taxable portion of benefits from these programs.
Reporting Requirements
Accurate reporting of short-term disability benefits is essential for compliance with tax regulations. Employers must report the taxable portion of disability benefits on the employee’s W-2 form.
Employees must include the taxable portion of benefits as income on their tax returns. The W-2 form provided by the employer clarifies the taxable amount. Retaining all documentation related to benefits and contributions is critical for accurate reporting. Consulting IRS forms and publications, such as Form 1040 instructions, can provide further guidance.
Failure to report these amounts accurately can result in penalties, interest, or audits. Employers should consider offering resources or guidance to employees to help them understand their tax obligations, reducing potential issues and fostering clarity regarding the tax implications of short-term disability benefits.