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Last year, my wife was on short term disability leave (maternity leave) for 6 weeks. CA SDI took care of 80% of her paycheck which I believe is completely tax free. 20% of her paycheck for this period was paid by her company which was taxed regularly for federal and state taxes.

Can we claim deduction on those taxes for the 20% of the paycheck or was the company correct in taxing her?

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As per TurboTax

Temporary disability, such as an injury, serious medical condition, or even pregnancy, short-term disability payments can be obtained through private insurers, and they may be part of an employer’s compensation to employees. Whether the payments are taxable depends on how and when they are paid.

Employer disability benefits

If you and your employer share the cost of a disability plan, you are only liable for taxes on the amount received due to payments made by your employer. So, if you pay the entire cost of a sickness or injury plan with after-tax money, you do not need to report any payments you receive under the plan as income. If your employer pays half the cost of premiums and does not deduct these payments from your pay, then you most likely must report half the payments received as income. Reimbursement of medical costs you’ve paid for after the plan was established are not taxable, but may reduce the amount of your medical costs deduction.

As per IRS

Finally, the applicable statutes and regulations do not distinguish between short-term and long-term disability plans. Thus, if an employer offers both short-term and long-term disability plans and permits employees to separately elect the contribution payment method for each plan, the law does not require aggregation of the contributions paid for each plan in determining the taxation of benefits. Benefits paid under a short-term or long-term disability plan will be taxed according to the contribution payment election made for each type of coverage.

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    In other words, the IRS gets it's bite--either from the payments or from the money you used to pay the premiums. – Loren Pechtel Apr 7 '15 at 17:24

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