If disability insurance from an employer has 75% of premiums paid by the employer and 25% by the employee, what portion of the disability benefits is taxable?

• A. Taxes must be paid on 25% of the benefits received
• B. Taxes must be paid on 50% of the benefits received
• C. Taxes must be paid on 75% of the benefits received
• D. Benefits are tax-free

Answer: (C)

The main idea is how disability benefits are taxed when the employer and employee share the premium payments. Disability benefits are taxed in proportion to how the premium was paid: the portion of the benefit that corresponds to premiums paid by the employer is taxable to the employee, while the portion corresponding to premiums paid by the employee with after-tax dollars is not taxed.

Here, the employer pays 75% of the premium and the employee pays 25%. Therefore, 75% of any disability benefit would be taxable, and 25% would be tax-free. For example, if the monthly benefit were $1,000, $750 would be taxable and $250 would not be taxed.

This is why the correct approach is that 75% of the benefits are taxable—the portion funded by the employer is treated as taxable income when benefits are received.