Q

Are disability insurance premiums tax-deductible?

A

Disability insurance premiums aren’t tax-deductible, but you may be able to deduct medical expenses worth more than 7.5% of your adjusted gross income as an itemized deduction.

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Long-term disability insurance monthly premiums cost as much as much as 1% to 3% of your salary. Unfortunately, you cannot deduct these disability insurance premiums on your taxes.

If you have medical bills because of an injury or illness that results in you claiming disability insurance benefits, you may be able to deduct those medical expenses on your taxes. This would require you to itemize deductions on your federal income tax return, and you can only deduct the expenses worth more than 7.5% of your income. It isn’t worth it for most people to itemize, but you may want to if you also have other itemized expenses, like mortgage interest.

Even though you can’t deduct your premiums for disability insurance, you won’t have to pay tax on any disability insurance benefits you receive.

What is a tax deduction?

Just about everyone needs to pay income tax every year, but you don’t pay tax on your entire income. You can deduct the cost of certain expenses you incurred during the year, like student loan interest. These deductible expenses decrease the amount of your income that is subject to tax. If your income was $70,000 but you had $10,000 of deductions, the income tax rates will now apply to just $60,000 of income.

What are itemized deductions?

If you have certain types of expenses, including some medical expenses. you can choose to itemize deductions instead of taking the standard deduction. Meanwhile, everyone who files a tax return can claim the standard deduction, which is a set amount based on your filing status.

The standard deduction is $12,400 for single tax filers in 2020 and married couples can take a standard deduction of $24,800. In 2021, the standard deduction will go up to $12,550 for single filers and $25,100 for joint filers.

Itemizing is only worth it if your itemized deductions are worth more than the standard deduction, which isn’t the case for most people. After the Tax Cuts and Jobs Act of 2017 greatly increased the standard deduction, only about 11% of taxpayers itemize deductions.

Tax-deductible medical expenses

While your disability insurance premiums are not tax-deductible, you may be able to deduct dental, vision, and medical expenses if the total you spent during the year was worth more than 7.5% of your adjusted gross income (AGI).

You can only deduct these expenses if you itemize your deductions and claim the medical expense deduction. Most peoples’ medical expenses don’t exceed 7.5% of their income, but they might if you have significant medical bills. When these plus other expenses, such as mortgage interest or other state and local taxes, exceed the standard deduction, then you can deduct them on your taxes.

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How to deduct insurance premiums

In general, you can’t deduct disability insurance premiums. There are certain cases where you might be able to deduct some type of insurance premium, but they usually apply to self-employed people and businesses:

  • Self-employed workers and business owners who pay homeowners or renters insurance for business property, including a home office, may be able to deduct insurance premiums as a business expense.

  • An employer may be able to deduct premiums for a life insurance policy if the employer buys a policy for an employee, and the employer isn’t the beneficiary of the plan.

  • Self-employed workers and small business owners may be able to deduct health insurance premiums if they buy a policy for themselves, a spouse, and dependents.

  • Certain long-term care insurance premiums are deductible as medical expenses if you itemize and claim the medical expense deduction on your income tax return.

  • Some auto insurance premiums may be deductible if you use your personal vehicle for business, but it requires keeping a lot of records for the care of your vehicle. It may be easier for you to just consider mileage reimbursement.

The IRS specifically says you can’t deduct disability insurance premiums or payments you make for a policy designed to replace income. In addition to disability insurance premiums, the following are not deductible:

  • Accident insurance or similar policies that cover the loss of life, limb, sight, etc.

  • Private policies that provide payment for loss of earnings

  • Any policies that pay you a guaranteed amount each week, for a stated number of weeks, if you are hospitalized for sickness or injury

  • The part of your auto insurance that provides medical insurance coverage for all persons injured in or by your car

  • Health insurance or long-term care insurance premiums if you elected to pay these premiums with tax-free distributions from a retirement plan made directly to the insurance provider. These distributions would otherwise have been included in income.

Will I have to pay taxes on disability insurance benefits?

If you pay for your disability insurance premiums with after-tax income, you won’t be taxed again when you claim disability insurance benefits. Private insurance you buy outside of your employer is almost always paid with post-tax income.

For employer-sponsored plans, you could owe taxes when you claim disability insurance benefits if you or your employer paid your disability insurance premiums with pre-tax income. In this case, your benefits are categorized as income and the percentage of your premiums that you paid with pre-tax income would be reported as taxable income. Not all employers pay disability insurance premiums plans with pre-tax income, so you will want to check the details of your plan. If your plan does use pre-tax income, make sure to plan for smaller benefits. For example, a benefit that’s supposed to be worth 80% of your income could end up being worth 70% or less after factoring in taxes.

Learn more about when disability insurance benefits are taxable.