Social Security Benefits &
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.
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
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.
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:
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
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.