Insurance Payouts: Taxable Gross Income?

Gross income is an individual's total earnings before taxes or other deductions. This includes income from all sources, not just employment, and is not limited to income received in cash; it also includes property or services received. Insurance payments that cover your bills are not taxable income. This means that they are not considered part of your gross income. However, any interest received from insurance payments is taxable and should be reported as such. Additionally, if you receive financial benefits from your insurance when you are temporarily disabled or sick, these benefits might be taxable.

Health insurance payments are not taxable income

Under the Affordable Care Act, the amount your employer spends on your health insurance premiums will appear on your W-2 form, but this should not be classified as income. If you pay the premiums of a health or accident insurance plan through a cafeteria plan and you did not include the premium amount as taxable income, the premiums are considered paid by your employer, and the disability benefits are fully taxable.

If your insurance payments only cover your medical bills, prescriptions, and hospital stays, then these payments are not taxable. Even though your insurance is essentially paying for these critical services, this will not be considered part of your annual income.

If your insurance pays for a high-tech medical exam, you cannot claim this as a deduction. However, if you paid a co-payment, you may be able to write this off if you have enough other deductions to make itemizing a better deal than taking the standard deduction.

Health insurance reimbursements can be taxable or non-taxable, depending on the type of reimbursement. Health Reimbursement Arrangements (HRAs) are tax-free for both the employer and employee, but health stipends are taxable income.

Life insurance proceeds are not taxable income

Life insurance payouts are generally not considered taxable income, but there are certain exceptions. The type of policy, the size of the estate, and how the benefit is paid out can determine if life insurance proceeds can be taxed.

Types of Insurance Payouts

If you are the beneficiary of a life insurance policy, you will not need to pay taxes on the death benefit you receive, especially if you receive it as a lump sum. However, if you choose to receive the death benefit as an annuity (a series of payments over several years), any interest accrued by the annuity account may be subject to taxes.

Size of the Estate

If the life insurance policy goes into an estate, and the value of the estate exceeds the federal estate tax threshold, estate taxes must be paid on the amount that is over the limit. As of 2024, the federal estate tax threshold is $13.61 million. Some states also assess inheritance or estate taxes, depending on the estate's value and the deceased's place of residence.

Other Instances

If you withdraw or take out a loan against your whole life policy's cash value, you may have to pay income taxes on the excess if you withdraw more than your cumulative premium payments. If you borrow against the cash value and the loan is still outstanding when the policy is terminated or surrendered, the loan amount in excess of the cumulative premiums may be subject to income taxes.

Additionally, if you surrender your whole life insurance policy, you can exchange it for a cash payment from the insurance company. If the surrender proceeds exceed the cumulative premiums, the excess may be subject to income taxes.

Life insurance proceeds are also not taxable income if you receive them as reimbursement of medical expenses for personal injury or sickness under an accident and health insurance contract.

Disability insurance proceeds are taxable income

Whether or not disability insurance proceeds are taxable depends on who pays the premiums. If you pay the premiums yourself, using after-tax dollars, then the benefits are not taxable. However, if your employer pays the premiums, or if you pay the premiums with pre-tax dollars, then the benefits are taxable. This is because the benefits are considered a form of income, and will be taxed according to federal income tax rates.

If both you and your employer contribute to the cost of the premiums, then only the amount you receive that is attributable to your employer's contribution is taxable. If you pay the premiums through a cafeteria plan, and you did not include the amount of the premium as taxable income, then the premiums are considered to have been paid by your employer, and the benefits are fully taxable.

If you receive disability benefits, you may be able to deduct your out-of-pocket medical expenses above any reimbursements, if you are eligible to itemize your deductions.

Insurance payments for bills are not taxable income

Insurance payments for bills are not considered taxable income. This is true even if your employer pays for your health insurance. Under the Affordable Care Act, the amount your employer spends on your premiums will appear on your W-2 form, but this should not be classified as income.

However, it is important to note that any benefits you receive due to your health insurance policy may be taxable. For example, if your insurance does more than just reimburse you for medical expenses, such as providing financial benefits when you are temporarily disabled or sick, these benefits might be taxable.

If you pay the premiums of a health or accident insurance plan yourself, you do not need to include any amounts you receive for your disability as income on your tax return. However, if your employer pays for the insurance policy, the benefits are taxable. If it's a split—for example, your employer pays 60% of the premiums—then 60% of the benefits are taxable.

Additionally, if you receive life insurance proceeds as a beneficiary due to the death of the insured person, this is generally not included in gross income and does not need to be reported. However, any interest you receive on the life insurance payout is taxable and should be reported.

Insurance payments for financial or disability benefits are taxable income

Whether insurance payments for financial or disability benefits are considered taxable income depends on the type of insurance and the nature of the premiums.

Disability Insurance

Disability insurance benefits are generally taxable if the premiums were paid with pre-tax dollars or by an employer. If you have an individual disability insurance plan and are not part of an employer-sponsored plan, you likely won't owe taxes on the benefits received. This is because the premiums for such plans are typically paid with post-tax dollars, and you are already taxed on this income.

However, if your employer pays the premiums or if the premiums are paid with pre-tax dollars, you will likely owe taxes on the disability benefits. In this case, the benefits are considered a form of income and are taxed according to federal income tax rates. The percentage of the benefit that is taxable is equivalent to the percentage of the premiums paid by your employer or with pre-tax dollars.

Health Insurance

While traditional health insurance benefits are usually not considered taxable income, related benefits such as financial or disability benefits provided by your employer may be taxable. If your insurance reimburses you for medical expenses such as doctor visits, hospital stays, and prescriptions, these payments are generally tax-free. However, if you receive financial benefits when you are temporarily disabled or sick, these benefits might be taxable.

Life Insurance

Life insurance proceeds received by a beneficiary due to the death of the insured person are generally not includable in gross income and do not need to be reported as taxable income. However, any interest received on the payout is taxable and should be reported.

If the life insurance policy was transferred to the beneficiary in exchange for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts. There may be exceptions to this rule, and you should refer to the appropriate IRS publications for more information.

Frequently asked questions