If you are receiving medical disability benefits from disability insurance you may have to pay taxes on that money.  There are a complicated set of rules and guidelines on medical disability taxes and you really should contact a tax professional before filing your returns.

Here are some of the ways used to determine if you will be charged medical disability taxes.

• If you purchased the disability insurance from an insurance company (as opposed to through your employer).  In this case you paid your premiums using after-tax dollars.  That is to say you used money from your income that had already been taxed. In this case you would not have to pay taxes on the benefits should you become disabled
• Your employer provides disability insurance as a benefit under your employment. You do not pay anything for this insurance as your employer covers all the costs for the premiums.  In this case if you receive benefits, there will be medical disability taxes applied to those benefits.  You did not pay for the premiums; therefore you did not pay any taxes on the premiums. This means the money you receive as benefits should become disabled is considered taxable.
• Your employer offers disability insurance but you must pay the premiums.  Often times the employer will allow you to pay for this coverage using after tax dollars through payroll deduction.  In this case you would not be charged medical disability taxes on any benefits you receive should you become disabled.

As you can see, it is a complicated topic! Basically if you paid taxes on the money used to pay for the insurance, you will not have to pay taxes on the benefit money.  If you did not pay taxes on the money used to pay the premiums, then you will have to pay taxes on the money you receive should you become disabled.

To make things even more complicated, this whole process runs on what is called a three year look back period.  Basically this means if you were paying premiums with money that had already been taxed for 2 years, but the 3rd year your employer picked up the premiums and you did not have to pay anything, then you would be responsible for paying 1/3 of the taxes on the benefits you receive should you become disabled.  Conversely, if your employer paid for the premiums for the first 2 years and on the 3rd year you had to pay for the premiums using money from your income that had already been taxed, only 1/3 of the benefit would be tax free.

It is strongly suggested that you consult a tax professional immediately if you are filing taxes for the first time while on disability.  The rules are complicated and a tax professional may be able to assist you in taking advantage of complicated loop holes and exceptions that you would not ordinarily be aware of.  You do not want to go this one alone! Owing the government even accidentally because you didn’t understand the rules can still cost thousands of dollars and lead to financial ruin!