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.