According to the Internal Revenue Service, disability insurance (DI) benefits (including VDI) which are considered a substitute for Unemployment Insurance are fully taxable.
Normally, if you do not work because of a disability and receive DI benefits, part or all of the benefits may not be taxable. However, if you claim the disability payments AFTER you are unemployed and begin receiving DI benefits because of the illness or disability, the benefits are considered a substitute for UI and are reportable for tax purposes up to your UI maximum benefit amount. (Federal Tax Regulation Section 1.85-1 states that DI benefits are considered to be in the nature of UI benefits when paid to an unemployed taxpayer who is ineligible for UI benefits solely because of the disability.)
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