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Taxes and Social Security Disability

What Is Taxable and How to Reduce Your Taxes

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Updated May 30, 2014

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Many people only think about income taxes in the weeks leading up to the April 15 income tax return deadline. Tax planning throughout the year, however, can mean a significant tax savings.

These steps are particularly important for people with disabilities who need a clear understanding of how their disability may change their tax liabilities, as well as what they can do to lower any tax obligation they may have.

Here are some steps you can take so that when the annual April income tax deadline arrives, you are well-prepared and can minimize your taxes.

Learn how Social Security Disability Insurance and Other Benefits are Taxed

You likely are familiar with how your work income or investment income is taxed, but people with disabilities also need to understand how disability-related sources of income will be taxed.

This can include:

  • Monthly Social Security Disability Insurance (SSDI) benefits. Generally, up to 50 percent of your Social Security disability benefits may be taxed. This is determined by adding one-half of your SSDI benefits plus all of your other income sources. You will owe taxes on any amount above a base level. A worksheet to check taxability of SSDI benefits is available on the Allsup website.
  • Lump-sum SSDI benefits. It can take more than two years to receive Social Security disability benefits, resulting in a lump-sum amount of back payments. Paying taxes on this amount in one year is a mistake and could be financially devastating. The IRS allows taxes on this lump-sum payment to be spread over previous tax years using the current-year tax return, with no need to file an amended return. However, the calculations are complex, so it’s a good idea to seek tax assistance. A list of free tax help resources for people with disabilities is available on Allsup’s website.
  • Other benefits. Tax treatment of other income sources varies. For example, workers’ compensation benefits and compensatory damages for injuries generally are not considered taxable. The taxability of long-term disability (LTD) insurance benefits depends on how the premiums were paid. Specifically, if you paid the premiums with after-tax dollars, the benefits are not included in your taxable income. If you paid long-term disability premiums with pre-tax dollars as part of a cafeteria plan, for example, or your employer paid your premiums, the benefits are taxable to you and must be included in your income.

Learn about Tax Credits and Deductions that can Lower Taxes

There are a variety of tax credits that may benefit you depending on your situation. The IRS regularly updates the amounts of these credits for each tax filing year. Among these are:

  • Earned income tax credit. The EITC is a refundable credit, meaning that when it is applied—any amount higher than a person’s tax bill can be received as a tax refund. To be eligible, a taxpayer or spouse had to be employed for a part of the year and meet certain income thresholds and investment income limitations.
  • Credit for the disabled. You are eligible for this credit if you receive taxable disability income from a former employer’s accident, health or pension plan and meet certain income requirements.
  • Dependent care credit. If you pay someone to care for a dependent or spouse with physical or mental impairments, you may be able to take a credit of up to 35 percent of day-care costs while you are working or looking for work.

Deductions are another way to reduce your tax bill. Some to consider include:

  • Increased standard tax deduction. Blind or visually impaired taxpayers may be entitled to a higher standard tax deduction.
  • Medical deductions may apply. Taxpayers who itemize can deduct medical costs equaling more than 7.5 percent of their adjusted gross income. Starting in 2013, you may only deduct medical expenses that exceed 10 percent of your adjusted gross income. Deductible expenses include medical and dental costs, travel expenses for treatment, long-term care insurance, medical insurance premiums, and costs for certain equipment for those with visual, hearing and other physical disabilities.
  • Deduct the costs of seeking your Social Security disability benefits. If you hired a representative, such as Allsup, to help you get your SSDI benefits, you can deduct the fee that you paid your representative from the taxable part of a lump-sum SSDI payment you received. To do so, you will need to itemize deductions on your tax return using Schedule A of Form 1040.

No one likes to pay taxes. For people with disabilities, you can improve your financial future by taking a closer look. With some advance planning, you can avoid paying more taxes than you need to and improve your potential for important tax benefits.

About the Author

Paul Gada is a tax attorney and the personal financial planning director for Allsup (www.allsup.com), a nationwide provider of Social Security Disability Insurance representation and Medicare plan selection services. As head of the Allsup Disability Life Planning Center, he focuses on Allsup’s efforts to help people with disabilities reclaim their lives and cope with their continuing financial and healthcare concerns.

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