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  • Income Insurance

Is Disability Income Tax Deductible? A Guide for Freelancers & Entrepreneurs

5 min

You’ve finally struck out on your own and become one of over 44 million Americans who are self-employed. Congratulations! It can be scary to leave the corporate world behind to set up a small business—especially in the current climate—but you’ve worked hard to make it happen.

Being your own boss comes with plenty of perks. Long lunch breaks, as many vacation days as you’d like, and if you want to, working in your pajamas (we won’t judge, we promise). But there’s also the not-so-fun side of running a business, like sorting out your expenses and finding ways to supplement your income if you suddenly face an unexpected illness or injury.

After all, one in four of us could be out of work for at least a year before we hit retirement age. When you’re working for yourself, where’s your safety net? That’s where Disability Income Insurance (or just disability insurance as its traditionally called) offered by Aseya can help you.

If you’re contemplating the idea of securing your income with disability insurance, “I’m sure I can count this as a business expense when its purpose is to support me if I can’t work, right?” Not so fast. There’s a little more to it than that, but we’re here to give you all the information that you need before making any final decisions.

We’ll help you navigate the world of disability insurance and answer your questions like:

  • Is disability income taxable?

  • Do you pay taxes on disability premiums?

With answers to those pressing questions in your back pocket, you’ll know exactly what you can and can’t write off as an expense when tax season arrives.

Is disability income tax-free?

Before we get into the details of what can be considered tax-free, let’s have a quick refresher of what exactly disability income is.

Disability insurance is there to replace some or most of your regular freelance or self-employment income if you find yourself with a medical issue that prevents you from working. It protects you and your dependents should the unexpected happen. You’ll be paid out a set amount each month that you can then use for your day-to-day living costs like bills, groceries, or even keeping your business running.

When you’re trying to determine the answer to the question, “Is disability taxable?”, there are two key features of your policy that you need to be aware of: the premium and the benefits. These are the points at which you’ll be exchanging money with the insurance company.

  • Your premium is the amount of money you pay to the insurance provider (usually monthly or annually) to maintain your policy.

  • Your benefit is the amount that the provider will pay out to you when you make a claim (and that claim is approved).

In most cases, the premium is not tax deductible but the benefits of a private, individual disability insurance policy (like the kind we offer at Asteya) are tax-free.

Can you get a tax deduction on disability insurance premiums?

How you choose to pay for your policy will determine whether or not you’ll be paying any taxes on your premium. If you’re self-employed, you’re likely going to be paying for your insurance policy with post-tax dollars, so you don’t need to pay any additional tax on your premium amount each month or year.

It’s important to remember though that disability insurance premiums aren’t like standard medical insurance that you get in a traditional workplace. You don’t have an employer taking out these premium costs from your paycheck, so you can’t deduct them come tax time.

There may be some expenses that you can deduct should you face an unexpected medical situation, but this will depend on the details of your policy and the type of illness or injury that you have. Generally speaking, medical expenses can usually only be deducted if they are more than 7.5% of your adjusted gross income and you’re planning to itemize your deductions.

The IRS provides a document called Publication 502 that outlines what you can and can’t deduct as medical expenses. For most self-employed individuals with income insurance, the IRS does not allow for any deductions where your policy is covering you financially as a private individual.

Although most disability insurance premiums are not tax-deductible, there may be an alternative option that you can make use of as a business owner. Business overhead expense insurance (also known as BOE insurance) is specifically used to cover business operating expenses like an office or store rental or mortgage costs, paying your employees' wages, or any other business maintenance needs.

The IRS states in Publication 535 that “overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness” can be considered a business expense and is, therefore, tax-deductible. Keep in mind that this is different from covering your individual income as the business owner and that’s why the IRS treats these types of policies differently.

Are disability benefits taxable?

The burning question that most entrepreneurs want to know is, “If I take out a policy, is long-term disability taxable?” This is an important question if you find yourself in a situation where you need to make a claim because that will ultimately impact how much money you’ll be able to use to support yourself and your family.

The good news is that, if you’re paying for your disability insurance with post-tax income (which you’re more than likely doing as a freelancer), any benefits you’re paid out as part of your policy are NOT taxable. You won’t be taxed again on the benefits end since you’ve already covered them on the premium end.

Just like workers’ compensation that you may have had in a traditional workplace, if your medical condition requires you to make a claim against your policy at any point, these benefits will be considered tax-free income. They may be used to replace the income that you’ve lost but, for the purposes of filing your taxes, if you’re not getting a deduction then the payout isn’t taxable.

If you’re receiving any kind of additional disability income outside of your insurance policy, you’ll need to check the fine print to determine whether or not this is taxable. Funding from Social Security disability, for example, is generally not taxable if your provisional income (that’s your modified adjusted gross income plus half of your expected Social Security benefits) is less than $25,000 for individuals or $32,000 for married-filing-joint applicants.

If your provisional income is over this limit, you could be taxed up to half of your Social Security benefits. Private insurance policies are often much clearer in their tax deduction status, so it may be more beneficial to use these funds first before tapping into other sources, especially if your income as a freelancer or business owner fluctuates every year.

There’s also an important caveat to note here when you’re a small business owner: If you decide to take out a BOE policy instead of individual income insurance, this will be considered taxable income if you choose to deduct the premium for this as a business expense.

You’ll need to weigh the pros and cons before your policy begins. You can elect to pay for BOE insurance with after-tax income, just as you would with an individual policy. If that’s the case, it will no longer be taxable income and you’ll receive any benefits tax-free. The choice is yours. If you’re fairly confident that you’ll never make a claim, deducting the premium may save you more on your taxes. But you’ll also run the risk of having a smaller benefit amount if you need to use the policy in the future, as you’ll need to pay taxes at that point.

As always, it’s smart to talk to your accountant or other tax professionals before making a decision and see what will be more helpful in your personal situation. If you don’t currently know somebody with that expertise that you can turn to, ask around your network for some recommendations—some other business owners you know might have referrals for trustworthy professionals.

Safeguard your income with tax-free funding

As with most areas of life, “it depends” is the go-to phrase when you’re trying to determine if your disability income tax will be deductible or not. It all comes down to when taxes were originally paid toward a policy.

Like retirement contributions, if you paid taxes on the income before you invested it, it’ll probably be tax-free when it’s paid out to you later. But if you’re using pre-tax dollars to fund your premiums or you’re getting a tax break up front, that income will become taxable later on.

There’s plenty to think about when it comes to deciding what your best course of action is with disability income insurance. But whichever option you choose, taking out a policy now is still one of the smartest business moves that you can make.

Protect your future income and enjoy the peace of mind that comes with knowing that you have a safety net in place. Contact Asteya today to begin your no-exam disability income insurance application.


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