Disability Claim Taxation (Benefit Tips ® - © 2012)

Claim payments to disabled employees are considered non-taxable income if the employee pays the entire cost of insurance. However, if the employer pays any portion of cost then claim payments are fully taxable. If both the employer and employee contribute toward the cost of disability insurance then disability claim payments are taxable but the disabled employee’s contribution toward the cost can be deducted for taxation purposes. For this reason, employers either pay 100% of the cost or nothing.

Since employer paid disability insurance is taxable, the coverage amount is typically 66.7% or 75% of earnings.

When employees pay the cost of disability insurance, either through direct payroll deductions or by having the cost added to their monthly taxable income, the coverage amount is typically 60% or graded to reflect after-tax earnings. Unfortunately, most disability policy does not consider the taxability of claim payments when reducing claim payments by sources such as CPP. A 60% non-taxable benefit is often reduced by the full amount of taxable income instead of the after-tax portion. A similar problem exists when a claimant mixes non-taxable partial disability claim payments with taxable earnings and bumps into the 100% of pre-disability earnings limit.