|
This information is courtesy of NOSSCR --
the National Organization of Social Security
Claimants Representatives.
This article gives general income tax
guidance with citations, and should not
be used as the basis for tax advice in
individual cases. Taxpayers should always seek
guidance from competent tax professionals, and
should use this page only as an aid to asking
the right questions.
Note: Social Security disability benefits
and retirement benefits are treated the same
for income tax purposes. SSI benefits are not
subject to income tax.
Common questions:
How should I handle income taxes on my
retroactive lump sum payment of disability
benefits?
How much of my ongoing Social Security
disability benefit is subject to income tax?
What about my attorney fee for the
disability appeal - is it deductible?
I owe most of the Social Security lump sum
to a long term disability carrier, so how do I
avoid double taxation?
Lowering the tax impact of a lump sum.
Congress has provided a special election
allowing a client to take advantage of the tax
exempt base amount for each of the retroactive
years represented in a Social Security lump
sum. [I.R. Code §86(e); see I.R.S.
Publication 915] In most cases, this special
election will be desirable, because it enables
the taxpayer to offset the lump sum with a
multiple of base amounts, described below.
Also, the election removes the need to amend
prior tax returns.
1099. Social Security is required to
send each benefit recipient an SSA-1099 by
February 1 of the following year, specifying
how much of the Social Security benefit
received in the lump sum was really a payment
for some prior year or years. The 1099 also
lists the attorney fee. These SSA-1099 forms
are often inaccurate, and the taxpayer must
use award notices to double check the 1099.
Income Tax on Social Security Benefits
The Basic Rule. Up to 50% of Social
Security benefits are taxable if total “provisional
income” (pensions, wages, tax-exempt
interest and one half of Social Security
benefits) exceeds a base amount: $25,000 for
single taxpayers and $32,000 for married
taxpayers filing jointly. At this level, taxes
are payable on the lesser of (1) 50% of Social
Security benefits received, or (2) one half of
the difference between provisional income and
the applicable base amount. Fortunately, this
is the end of the income taxation picture for
most recipients of disability benefits.
The Second Tier. A second tier of
income tax - reaching up to 85% of Social
Security benefits received - kicks in (1) for
single taxpayers with provisional income over
$34,000, (2) for married taxpayers filing
jointly with provisional income over $44,000,
and (3) for all married taxpayers who file
separate returns, but do not live apart.
For these second-tier categories, income
taxes are payable on the lesser of (A) 85% of
Social Security benefits or (B) the total of
(1) 85% of the difference between provisional
income and the applicable adjusted base amount
($34,000/$44,000), plus (2) the lesser of (a)
half the benefits or (b) $4,500 (for singles /
$6,000 (for married couples filing jointly).
The adjusted base amount for married persons
filing separately but living together is zero;
taxes are payable on the lesser of 85% of
benefits or 85% of provisional income.
Attorney Fee Deduction. If a
taxpayer discovers that some of the Social
Security lump sum - when added to regular
benefits received in the same year - turns out
to be taxable, the attorney fee may be
deducted from income, but only to the same
extent that Social Security is taxed. For
example, if a taxpayer paid tax on 50% of SSA
benefits received, the taxpayer may deduct
half of the attorney fee paid or incurred
during the same year. [IRS Revenue Ruling
87-102] The taxpayer faces the burden of
filing an itemized return, of course, and this
limited deduction is further subject to the
“2% of adjusted gross” ceiling on
miscellaneous itemized deductions.
Worker’s Compensation Reduction.
Social Security disability may be reduced for
worker’s compensation and other public
disability benefits. Oddly, the amounts
deducted are included as benefits received for
purposes of income tax. In effect, state
worker’s compensation is rendered taxable in
an amount equal to the Social Security
reduction, but only to the extent that Social
Security is taxable for the year. [I.R. Code
§86(d)(3)]
Auxiliary [child or spouse] benefits.
Benefits are included in the taxable income of
the person who has the legal right to receive
them. For example, a child’s benefits are
added to the child’s other income (if any)
to determine taxability, even though the
benefits are paid on the parent’s earnings
record. The child receives a separate
SSA-1099.
Income Tax Withholding. Voluntary
Tax Withholding (VTW) from Social Security
benefit income will help some taxpayers avoid
quarterly estimated tax payments or an onerous
lump sum due by April 15th. To begin or modify
a withholding request, submit completed IRS
Form W-4V to a local Social Security office.
The available withholding rates are 7, 10, 15
or 27 percent. The form is posted on the
Social Security web site: www.ssa.gov/taxwithhold.html.
LTD reimbursement. What if the
taxpayer used all or part of a Social Security
back payment to reimburse a long-term
disability carrier? Special tax relief is
available under §1341 of the Internal Revenue
Code, again avoiding the need to amend a prior
tax return. See IRS Publication 525. If the
repayment to the LTD carrier is under $3,000,
the taxpayer gets a deduction on the current
year’s tax return. For repayments over
$3,000, the taxpayer chooses either the
deduction or a tax credit for the excess tax
paid in the prior year. A subtle tax issue to
watch: LTD reimbursements to the carrier also
cause “phantom” taxable income in some
cases, due to the separate 1099 forms issued
for the year by SSA and by the carrier.
Deductions for the Self-Employed.
Since the self-employed pay all of their
Social Security and Medicare taxes, these
workers receive a Social Security tax
deduction and an income tax deduction at tax
time, designed to achieve parity with the
employed, who do not pay FICA or income tax on
the value of the employer's FICA tax payment.
For the Social Security tax deduction, the
self-employed deduct 7.65% of net earnings
before computing the tax at 15.3%. For the
income tax deduction, 50% of the net social
security tax liability (after applying the
Social Security tax deduction above) is
deducted from gross earnings as a business
expense.
Back to Top
|
