If both the taxpayer and the employer pay the premiums for the plan, the disability benefits paid due to the employer's payments are taxable, according to the IRS. If the premiums are paid completely by the employee, the disability benefits are not taxable.
If an employee pays the premiums through a cafeteria plan and did not include the amount of the premium as taxable income, the premiums are then considered to have been paid by the employer, explains TurboTax. Therefore the disability benefits are fully taxable. For the five states that sponsor state disability plans that are funded by payroll taxes, whether or not the benefits are taxed is determined by the state, according to Zacks.