People collecting disability benefits may still need to file and may owe income taxes on their disability payments. This is true whether the disability payments come from Social Security or from disability insurance plans or both. The rules vary between public and private benefit plans and can be complicated. It is recommended that you consider hiring a tax consultant at least for the first tax year of receiving disability benefits.
While most states' tax laws tend to mirror those of the IRS, there may be minor differences that should be checked when filing. This article deals strictly with federal income taxation by the IRS.
It should also be noted that any earnings from part-time work while also collecting disability would be considered taxable income and may have an effect on how the disability benefits are taxed.
Supplemental Security Income (SSI). Because SSI is a needs-based program for people with limited income, it is the rare exception that a person collecting any portion of SSI benefits would owe income taxes. People receiving SSI benefits, as their only source of income would not be taxed on that benefit. You may not need to file a tax return; the Web site at www.irs.gov/individuals/article/0,,id=96623,00.html will help you determine whether or not you need to file.
Social Security Disability Insurance (SSDI). Most people receiving SSDI benefits will need to file an income tax return, even if there may be little or no tax due. However, if there is additional income to SSDI benefits such as wages, self-employment, interest, dividends, pension, taxable disability insurance, this can cause a portion of the SSDI benefits to also be taxable.
Rather than provide a separate, lower tax table for Social Security benefits, the IRS provides a break by taxing only a portion of the Social Security benefits depending on the amount of other income. No one pays federal income tax on more than 85% of his or her Social Security benefits based on IRS rules. If you:
If you do have to pay taxes on your Social Security benefits, you can make quarterly estimated tax payments to the IRS or choose to have taxes withheld from your benefits. For more information about taxation of benefits, see IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
Note: These dollar amounts are not indexed for inflation.
Every January you will receive a Social Security Benefit Statement (Form SSA-1099) showing the amount of benefits you received in the previous year. You can use this statement when you complete your federal income tax return to find out if your benefits are subject to tax.
Although you're not required to have federal taxes withheld from your Social Security benefits, you may find it easier than paying quarterly estimated tax payments. To have taxes withheld from your Social Security payments, you should complete IRS Form W-4V (Voluntary Withholding Request). This form is available on line at www.irs.gov/pub/irs-pdf/fw4v.pdf or by calling the IRS at 800.829.3676.
On the W-4V, you can select what percentage of your monthly benefit amount you want withheld either 7%, 10%, 15% or 25%. Only these percentages can be used. Flat dollar amounts are not acceptable. After you've made your selection, sign and return the form to your local Social Security office by mail or in person.
For more information about Social Security benefits and your taxes, there are two IRS publications you will find helpful:
You can order these by calling the Internal Revenue Service's toll-free telephone number, 800.829.3676, or you may access them on line at www.irs.gov.
For private disability benefits, the IRS looks to tax either the premiums paid for the disability insurance or the benefits paid to the claimant, but not both. This can best be explained by example:
Some employers who usually purchase long term disability for their employees will allow employees to elect to pay for their long term disability coverage with after tax dollars through payroll deduction, just for the purpose of making any future disability benefit payments tax free. If your employer offers this alternative, it is recommended that you seriously consider taking advantage of it. Having disability benefits income tax free can greatly enhance the quality of life when income is already lowered by the disability itself.
It should be noted that there is a three year look back period to this rule. This means that once you have paid the premiums with after tax dollars for three years, your benefits will be entirely tax free. If, however, you become disabled before the three years expires, your benefits will be taxable in the same proportion as the premiums paid. If you had paid the premiums for only one year and your employer paid the two prior years, only one-third of the benefit would be tax free. These rules apply to both short-term and long term disability.
As you can see from the explanations above, the taxation of disability benefits whether from Social Security or private insurance is a complicated issue. People starting to file taxes for the first time while on disability should either retain experienced tax counsel or take advantage of one of the many programs that offer free income tax assistance.
Jacques Chambers, C.L.U., is a benefits counselor in private practice with over 35 years experience in health, life and disability insurance and Social Security disability benefits. He can be reached by phone at 323.665.2595, by e-mail at firstname.lastname@example.org, or through his Web site at www.helpwithbenefits.com.