How to Calculate Taxes on a Social Security Disability Back Payment
Applicants for Social Security Disability Insurance payments must frequently wait for their disabled status to be confirmed and their SSDI eligibility approved. Once the payments begin, the recipient is entitled to back pay from the point at which his disability began, minus a five-month waiting period. This is paid in one or more lump sums and is subject to taxes.
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Instructions
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List the entire back pay lump sum amount on your tax return for the year in which you receive the payment. You must list it in this way regardless of the time covered by the payments.
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Use the worksheets in IRS publication 915 to see if you can save money by electing to be taxed on payments as if you had received them in the tax year that the benefits cover, rather than the tax year in which you actually received them.
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Note your decision to make this election on your tax return, if doing so will save you money. The precise instructions for doing this depend on the tax return you complete and its current design. Check the instructions at the end of worksheet four in the latest edition of IRS publication 915 to make sure you complete the tax return correctly. As of 2011, doing this for form 1040 involves writing LSE, meaning Lump Sum Election, to the left of box 20A, then writing the total amount of back pay received in box 20A, and the amount of back-pay benefits that will be taxed in box 20B.
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Claim a deduction for any expenses you paid in order to get the back pay, for example a fee paid to a benefits advice company.
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Claim a deduction for any amounts that you originally received from a disability-related insurance policy and were ordered to repay once you got the SSDI back pay.
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Tips & Warnings
Whether it works out better to elect to be taxed on the payments as if they were received in a previous year depends on your other income and deductions in each year, and which tax bracket you fell in to.
The rules for taxation of SSDI back pay can be complicated. If you are in any doubt, seek professional advice.
