Individuals with Disabilities Face Added Complexities at Tax Time: Allsup Answers Questions to Help Save on Taxes

Business Wire, Feb 20, 2008

Knowing about taxability of Social Security disability benefits and lump-sum retroactive payments, tax credits and tax deductions, and the importance of filing a return to get the one-time tax rebate all play a role in ensuring those with disabilities lower or eliminate their tax bill.

BELLEVILLE, Ill. -- More than 8.5 million working-age adults either rely on Social Security Disability Insurance (SSDI) benefits as a primary source of income or are awaiting a decision to receive their SSDI benefits. Along with the complexities of SSDI and managing their disability comes an added layer of complexity at tax time, according to Allsup (www.allsup.com), which represents tens of thousands of people in the SSDI process each year.

"For most of these individuals, not only is there a significant change in their health or medical well-being, but there is also a substantially reduced income level," said Paul Gada, a tax attorney and financial services product manager for Allsup. "This combination makes understanding and minimizing their tax obligations a crucial part of their financial well-being.

"Tax issues are more important than ever this year since even individuals that only receive minimal SSDI benefits and who may not generally owe taxes will need to file a return if they want to receive the one-time tax rebate," he added.

Below, Allsup answers common questions individuals with disabilities have about their income tax obligations.

Are Social Security disability benefits taxable?

Yes. Both monthly SSDI benefits and lump-sum retroactive payments of SSDI benefits are subject to federal income tax. The state tax treatment of SSDI benefits varies, but most states do not tax SSDI benefits.

The federal tax rules applying to monthly benefits are fairly straightforward, but those related to lump-sum payments of SSDI benefits are complex.

* General SSDI benefits. As with all Social Security benefits, up to 50 percent of SSDI benefits are potentially subject to tax each year. To determine this, an individual adds up half his SSDI benefits plus all his other income sources, including taxable pensions, wages, interest, dividends, etc., as well as tax-exempt interest income. Married individuals filing jointly will have to pay taxes on a portion of their SSDI proceeds if their total exceeds a base amount, which for 2007 is $32,000. Most other filers will have to pay taxes on proceeds that exceed a base amount of $25,000.

However, as much as 85 percent of SSDI benefits can be taxed if the total of one-half of a person's benefits and all her other income for 2007 exceeded $34,000 as a single filer or $44,000 for those who are married filing jointly.

"The average monthly SSDI benefit in 2007 was slightly over $1,000. As a result, if this was your major source of income, it's likely you will not have to pay any taxes or will have a very low tax bill, particularly if you take advantage of available credits and deductions," said Gada.

* Lump-sum SSDI benefits. Trying to calculate the taxes owed on a lump-sum retroactive payment, which includes SSDI benefits owed for earlier years, gets far more complex.

"There are more than 1.4 million disability claims pending with the Social Security Administration, with the average time to receive an award taking two to four years," said Gada. "So, for example, if it takes 42 months to receive your award, you could receive a lump-sum payment of more than $40,000. That's a lot of income at once and could wreak havoc on your tax obligation."

Fortunately, there is a special election that allows lump-sum payments to be spread over previous tax years that represent the retroactive pay period, using just the current year tax return - with no need to file any amended returns. Unfortunately, the calculations required to figure this out manually over a multi-year scenario are extremely difficult. As a result, Gada encourages individuals to invest in tax preparation software or use a tax professional to prepare their taxes.

Individuals who received disability payments through an employer's or insurance company's long-term disability policy and had to repay the employer or insurance company for the disability payments can take an itemized deduction for all or part of the repayments.

What credits and deductions are available to lower my tax bill?

Individuals with disabilities may be able to lower the taxes they owe through disability-related tax credits and deductions, as well as due to having reduced income. Among the tax breaks to evaluate are:

* Credit for the disabled. This credit is available if an individual receives taxable disability income and has 2007 adjusted gross income under: $17,500 for single filers; $20,000 if filing jointly and only one spouse is eligible for the credit; and $25,000 if filing jointly and both spouses are eligible.

* Representation cost. Individuals can deduct the expenses for SSDI representation required to secure their benefits.

* Dependent care credit. An individual who pays someone to care for his dependent or spouse who is not physically or mentally able to take care of herself may be able to receive a credit of up to 35 percent of the care provided while he was working or looking for work. The amount of the credit decreases as earnings go up, but a minimum credit of 20 percent is available to those with adjusted gross earnings over $43,000.