This is a question that should be answered by a tax advisor. As disability insurance lawyers we are not authorized to give tax advice. The general rule is that if you use post-tax dollars to pay the premiums, then the disability insurance benefits should not be taxable.
Bill Bischoff, recently wrote the following article on this issue for smartmoney.com:
Disability Insurance: Long-term disability coverage protects you against lost earnings during any lengthy period out of work because of a disability. The catch? Most long-term disability, or LTD, policies limit benefits to 60% or 70% of earnings before income taxes. That’s generally OK as long as you don’t have to pay income taxes. But if you do, you’re probably going to lose 30% to 40% (or more) to federal and state taxes. LTD benefits are generally income-tax-free when you, rather than your employer, pay the premiums. But if your employer pays the premiums as a tax-free fringe, LTD benefits will be fully taxable to you. The same is true if you set aside part of your salary pretax to pay the premiums. If LTD benefits would be taxable because your employer is paying the premiums, the preferred solution is to arrange for the premiums to be paid with aftertax dollars through withholdings from your checks. The other alternative is to buy a supplemental LTD policy. The idea is to buy enough extra coverage to cover the income-tax hit on the benefits that you would receive under the company-provided coverage.