Whether or not sickness and injury benefits are taxable often depends on who paid for the insurance coverage.  Generally, if your employer paid for personal injury and accident insurance for you, any benefits you receive are taxable to you.  If both you and your employer pay for the insurance plan, you only have to pay tax on the amounts you receive that are due to your employer’s payments.    And if you pay the entire cost of the insurance plan, normally none of the benefits you receive would be taxable.  If sickness and injury benefits are taxable, they would normally be reported on the wages, salaries, tips, etc. line of your tax return.

Health Insurance Plans

When an employer pays the costs of a health insurance plan for its employees and their spouses and dependents, the cost of the health insurance premiums is a non-taxable benefit for employees.  It is not subject to social security or Medicare, or federal income tax.  This also applies to reimbursements you receive from a self-insured medical reimbursement plan that your employer maintains.

Benefits in the form of medical expenses that are paid directly to the health care provider on your behalf or that are reimbursed to you are generally not taxable either.  But insurance reimbursements need to be taken into account when calculating your tax deductions, and must be subtracted from your actual medical expenses in determining the amount of medical expense you can claim as an itemized deduction.

If you do not deduct a medical expense because your total medical expenses were less than the 7.5% of adjusted-gross-income limit for deducting medical expenses, or because you do not itemize, you do not have to include the reimbursement up to the amount of the expense in your income.  If the reimbursement is more than the expense, you may have to include the excess in your income.

Cafeteria Plans

If you are covered by an accident or health insurance through a cafeteria plan, any benefits you receive would not be taxable if the amount of the premiums was included in your income.  In this case you would be considered to have paid for the coverage.  But if the premiums are not included in your income, you are not considered to have paid them, and any benefits would be taxable to you.

Excess Reimbursements

If a health insurance plan reimburses you more than your actual medical expenses, you may have to include the excess in income.

• If your employer did not pay any of the cost of the health insurance plan, none of the excess reimbursement you receive is taxable.
• If your employer paid for the coverage but included the premiums in your taxable income, none of the excess reimbursement you receive is taxable.
• If your employer paid the entire cost of the health insurance premiums and did not include the cost in your income, the entire excess reimbursement is taxable to you.
• If you paid part of the premiums, part of the excess reimbursement is taxable.

In this last case, if both you and your employer contributed to paying the premiums for the health insurance plan, you have to include in your taxable income the proportional part of the excess reimbursement that corresponds to the employer’s contribution to the cost.  For example:

• if the total health insurance premium for the year is $1,200,
• you pay $300 and your employer pays $900, and
• you receive an excess reimbursement of $400,
• you would have to include 75% of the excess reimbursement in your taxable income (your employer’s contribution of $900 divided by the total cost of $1,200).
• Your taxable part of the excess reimbursement would be $300 (75% of $400 = $300).

Health Reimbursement Arrangements

A health reimbursement arrangement (HRA) is a plan, funded by an employer, that reimburses employees for medical care expenses and allows employees to carry forward amounts they do not use.  An HRA is funded entirely by the employer (not by an insurance company) and the reimbursements you receive for medical expenses are not taxable, up to a certain amount per coverage period.

Long-Term Care Insurance

Benefits you receive from a long-term care insurance contract are generally not taxable.  The contract must be for qualified long-term care services.  These are services for taking care of a chronically ill individual, and the plan of care must be prescribed by a licensed health care practitioner.  There is a limit on the amount that can be excluded, that is generally expressed as a dollar amount per day. The limit applies to the total long-term care benefits and any accelerated death benefits paid on a per diem basis under a life insurance contract.  The excludible and taxable portions of the long-term care and accelerated benefits received for a given year are calculated in Section C of Form 8853, Archer MSAs and Long-Term Care Insurance Contracts.

Disability Pensions

Disability pay is taxable based on the general rules that apply for sickness and injury benefits.  If your employer pays the entire cost of the plan, the disability benefits are taxable to you.  If you and your employer share in the cost of the plan, you would be subject to income tax only on the part of your disability pension or annuity that corresponds to your employer’s payments.

If you retire on disability, the pension or annuity income you receive is generally taxable.  It should be reported as wages until you reach minimum retirement age.   Once you reach minimum retirement age, disability payments are taxable as pensions or annuities.  They should be reported to you on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.  But there is a tax credit available for persons who are totally and permanently disabled. This credit is claimed by filing Schedule R, Credit for the Elderly or the Disabled, with your tax return.

Military and Government

If you receive disability or other sickness or injury benefits connected with your service in the military or for the government, you may be able to exclude the benefits from your taxable income.  This exclusion applies for disability benefits you were already entitled to receive before September 25, 1975, disability benefits for a combat-related injury, and any disability benefit you would be entitled to receive from the Department of Veterans’ Affairs (VA).

Pensions based on years of service are generally taxable, but if you qualify to exclude a disability benefit, part of the pension would not be taxable.  You would not have include in your taxable income the part of the pension you would have received if your pension had been based on a percentage of your disability.  If you retire from the service based on years of service, and later you receive a  retroactive service-related disability rating from the VA, you can exclude your retirement pay for the retroactive period covered, up to the amount of the VA disability benefits you would have been entitled to receive.  You can file an amended return to recover any tax you already paid on the part of the pension that is excludible.

If you receive a lump sum disability severance payment and later you are awarded VA disability benefits, you can exclude the entire lump sum payment from your taxable income.

Workers’ Compensation

Benefits you receive for occupational sickness or injury are exempt from tax if they are paid under a workers’ compensation law.  This exemption from tax would also apply to survivor benefits paid to your beneficiaries.  But retirement plan benefits you receive based on your age, length of service, or any prior contributions you made to a workers’ compensation plan are not exempt from tax, even if you retired because of an occupational sickness or injury.

If you receive a disability pension that only provides benefits to employees who have disabilities connected with their service, part of that disability pension is workers’ compensation that is exempt from tax, and part is a pension, based on years of service, that is taxable as a pension or annuity.

If you return to work after a sickness or injury for which you received workers’ compensation, and you are assigned light duty when you return, your wages are taxable. 

If part of your workers’ compensation reduces the amount of social security or railroad retirement benefits, that part may be taxable.  On your annual Social Security Benefit Statement (Form SSA-1099) this reduction will be shown under “Description of Amount” in box 3.  If you are receiving railroad retirement benefits, the credit will be reported in box 6 entitled “Workers’ Compensation Offset” on your Statement of Payments by the Railroad Retirement Board for the Year.  The amount of the Workers’ Compensation Offset is included in the Gross and Net Social Security Equivalent Benefit Portion of Tier I paid for the year, and is reported in box 6 only for your information.

Other Benefits

In addition to benefits from health insurance plans, long-term care insurance plans, disability pensions, and workers’ compensation, there are some other types of sickness and injury benefits you might receive, some of which are taxable and some not.

Sick pay you receive under the Railroad Unemployment Insurance Act are taxable, but not if the pay is for an on-the-job injury.  Black lung benefits payments are not taxable.  If you are covered under the Federal Employees’ Compensation Act (FECA) and you receive personal injury or sick pay, you do not have to include the payments in your taxable income.  In the case of death, these payments are not taxable to the beneficiaries either.  But the amounts you receive as continuation of pay for up to 45 days while a claim is being processed are taxable income to you.  Also, amounts that you receive under the FECA that reduce your social security or railroad retirement benefits may be taxable, as is the case with Workers’ Compensation.

Some other types of compensation you may receive for sickness or injury, that are not taxable to you, include compensatory damages, benefits you receive under a no-fault car insurance policy for loss of earnings, and compensation for permanent loss or loss of a function or part of your body.