Private Disability Insurance

• Workers purchase individual disability insurance policies directly from insurance companies. There are different policy coverage lengths available to workers. Disability coverages can last for several weeks or for the remainder of their lives. Insurance premiums are determined by several factors including the workers' health, job occupations and salaries. Higher premiums are charged to workers considered higher risks. However, disability settlements from private disability insurance plans are paid to workers tax-free, since premiums are paid with after-tax dollars.
  
  

Group Disability Insurance

• Workers also participate in group disability plans sponsored by their employers. Companies offer short- and long-term disability coverages as well. Insurance premiums are determined by information collected on the whole group. However, employers generally share in the costs of paying for disability insurance which can cause disability benefits to be taxed by the IRS. If the employers pay all of the premiums costs, the entire amount of disability benefits received by workers are taxable by the IRS. If employers pay a percentage, such as 50 percent, of the insurance premiums, only half of the disability benefits are considered taxable compensation.
  
  

Workers' Compensation Insurance

• Employees hurt on the job may qualify for workers' compensation benefits. Generally, benefits replace up to two-thirds of the employees' salaries and cover medical and vocational expenses as well. Workers' compensation benefits are generally paid out on a tax-free basis. However, the amount of workers' compensation benefits that reduce an individual's social security disability benefits are subject to taxation according to the IRS.
  
  

Social Security Disability

• The Social Security Administration distributes disability benefits to workers and their families on a tax-free basis. This is a federal program and entitled to all Americans who meet its requirements. However, if beneficiaries have earnings, dividends or other sources of taxable incomes and, combined with their Social Security disability benefits, exceed income guidelines, their disability payments are taxed by the IRS at normal income tax rates. For example, if beneficiaries' combined incomes top $25,000 per year, up to 50 percent of their Social Security disability benefits are taxed and up to 85 percent if their incomes exceed $34,000. If beneficiaries are married, up to 50 percent of their benefits are taxed if their household incomes top $32,000 and up to 85 percent if their incomes surpass $44,000 per year.
  
  

State Temporary Disability Insurance

• Workers in several states are covered by short-term disability plans sponsored by their state governments. New Jersey, New York, Rhode Island, California and Hawaii provide disability coverages lasting up to one year. Benefit amounts vary by state. For example, California workers receive benefits replacing 55 percent of their pre-disability salaries, while residents of Hawaii get 58 percent. Nearly all of these states distribute tax-free disability benefits. The exception is New Jersey, which requires workers to report their payment amounts on their individual tax returns.