January 17 2023

Disability Payments and Taxes

Table of Contents

Disability Payments and Taxes

If you become disabled and you begin taking money out of your retirement plan, you won’t have to worry about a penalty for early distribution, but you still need to report this income on your tax return.

Things to know about disability and your retirement plan:

-If both you and your employer paid into your disability plan, only your employer’s portion will be reported as income.

-You will not be taxed on amounts paid to reimburse you for medical expenses after you became disabled. If you were reimbursed for medical expenses before you became disabled, you may have to include some or all of that as income.

-Amounts you receive for personal injury or sickness through an accident or health plan that was paid-for by your employer is considered taxable income.

Need help filing your taxes?
Click here to Book an online appointment

If your employer paid for an accident or health plan and you receive payments from that plan, that income is taxable. But, if you paid for the cost of such a plan, the income is not taxable.

Accrued Leave Payment

If you retire on disability, any lump-sum payment you get for an accrued annual leave is considered part of your salary and is taxable.

Retirement and Profit-sharing Plans

If you receive payments from a retirement or profit-sharing plan that does not support disability retirement, these payments will be reported as a pension or annuity and not disability.

How to Report Disability Income on Your Tax Return

A disability pension that was paid for by your employer needs to be included as income on your tax return. Any disability pension you receive is included as income on your tax return if your plan is paid for by your employer.

Before Minimum Retirement Age:

Report on Line 7 of Form 1040.

At Minimum Retirement Age and After:

Report on Line 16b of Form 1040.

Military and Government Disability Pensions

— Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. (“Publication 907 (2022), Tax Highlights for Persons with Disabilities …”) The payments will be reported on line 16b of Form 1040.

Military and Government Disability Pensions

Some military and government disability pensions are taxable – here’s an overview.

Service-connected Disability. You may be able to exclude the income you receive as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services:

— The armed forces of any country

— The National Oceanic and Atmospheric Administration

— The Public Health Service

— The Foreign Service

Conditions for exclusion: Do not include disability payments as income if any of the following conditions apply:

— You were entitled to a disability payment before September 25, 1975.

— You were a member of a listed government service or its reserve component or were under a binding written commitment to become a member, on September 24, 1975. (“Are Long-Term VA Disability Benefits Taxable?”)

— You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:

a) Results directly from armed conflict,

b) Takes place while you are engaged in extra-hazardous service, (“IRS Publications for Military Disability Compensation”)

c) Takes place under conditions simulating war, including training exercises such as maneuvers, or

d) Is caused by an instrumentality of war.

You would be entitled to disability pay from the Department of Veterans Affairs (VA) if you filed an application for it. “Your exclusion under this condition is equal to the amount you would be entitled to receive from the VA.” (“Is my military retirement pension taxable if I am a 100% … – Intuit”)

Pension Based on Years of Service

If you receive a disability pension based on years of service, you need to report it as income on your tax return.

However, if the pension qualifies for the exclusion for a service-connected disability, don’t include the part of your pension that you would have received if the pension had been based on a percentage of disability.

Retroactive VA Determination

If you retire from the armed services based on years of service and you are later given a retroactive service-connected disability rating by the VA, your retirement pay for the retroactive period is not included as income on your tax return (up to the amount of VA disability benefits you would have been entitled to receive). You can claim a refund of any tax paid on the excludable amount (subject to the statute of limitations) by filing an amended return on Form 1040X for each previous year during the retroactive period. (“Retroactive VA Disability Tax Implications?”)

If you receive a lump-sum disability severance payment and are later awarded VA disability benefits, do not include in your income the part of the severance payment equal to the VA benefit you would have been entitled to receive in that same year. However, you must include in your income any lump-sum readjustment or other non-disability severance payment you received on release from active duty, even if you are later given a retroactive disability rating by the VA.