Generally, you must report as income any amount you receive for your disability through an accident or health insurance plan paid for by your employer.

If both you and your employer have paid the premiums for the plan, only the amount you receive for your disability that is due to your employer's payments is reported as income. If you pay the entire cost of a health or accident insurance plan, do not include any amounts you receive for your disability as income on your tax return. If you pay the premiums of a health or accident insurance plan through a cafeteria plan, and the amount of the premium was not included as taxable income to you; the premiums are considered paid by your employer, and the disability benefits are fully taxable.

Refer to Publication 525, Taxable and Nontaxable Income, for more details. If the amounts are taxable, you can submit a Form W-4S (PDF), Request for Federal Income Tax Withholding, to the insurance company, or make estimated tax payments by filing Form 1040-ES (PDF), Estimated Tax for Individuals.

Amounts you receive from your employer while you are sick or injured are part of your salary or wages. Report the amount you receive on the line for Wages, salaries, tips, etc, on Form 1040 (PDF); Form 1040A (PDF); Form 1040EZ (PDF). You must include in your income sick pay from any of the following:

Payments you receive from qualified long-term care insurance contracts will generally be excluded from income as reimbursement of medical expenses received for personal injury or sickness under an accident and health insurance contract. Also, certain payments received under a life insurance contract on the life of a terminally or chronically ill individual (accelerated death benefits) can be excluded from income. Refer to Publication 907, Tax Highlights for Persons with Disabilities.

You may be able to deduct your out of pocket expenses for medical care above any reimbursements, if you are eligible to itemize your deductions. You will need to review Publication 502, Medical and Dental Expenses.

For more information, refer to Publication 907, Tax Highlights for Persons with Disabilities.

References:

Source: http://www.irs.gov