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Please refer to the IRS publication 525 - http://www.irs.gov/pub/irs-pdf/p525.pdf page 17
Generally, you must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income.
If you pay the entire cost of an accident or health plan, do not include any amounts you receive from the plan for personal injury or sickness as income on your tax return.
Long-term care insurance contracts generally are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness.
Social Security and/or Medicare taxes are withheld from wages - non-taxable disability benefits are not wages and therefore FICA taxes are not due.
Arizona taxes are based on federal adjusted gross income - see line 12 - http://www.revenue.state.az.us/Forms/2007/140_2D.pdf
Additionals to income - see line 13 and Part B - there is no disability benefits that are non-taxable on the federal tax return - so such income is not taxable for Arizona as well.
I agree with you - based on the information you provided - this income is not taxable neither on federal level nor for Arizona.
Please provide all information above to your tax preparer for considerations.