When SSDI benefits are approved, recipients often receive a lump sum back payment covering the months or years they waited for approval.
Here’s what you need to know about the tax implications of these payments:
Taxability of Lump Sum Back Payments
Lump sum back payments of SSDI benefits are taxable and can significantly increase the recipient’s income for the year they are received.
This can lead to a higher income tax liability, as the entire lump sum is considered income for the current year.
Lump-Sum Election Method
To mitigate this issue, the IRS allows recipients to use the lump-sum election method.
This method allows you to assign back pay benefits to the year they should have been received, rather than the year they were actually received.
This can help reduce your taxable income for the current year and avoid higher tax liabilities.
Here’s how it works:
- Determine the Years Covered: Identify the years covered by the back pay benefits.
- Calculate Income for Each Year: Calculate your income for each year, including half of the SSDI benefits for that year.
- Apply the Lump-Sum Election: Use the lump-sum election method to assign the back pay benefits to the appropriate years.
- Report on Form 1040: Report the taxable portion of your SSDI benefits on Form 1040, using the lump-sum election method to reduce your taxable income.
When you use the lump-sum election method, you recalculate the taxable part of all your benefits for the previous years (including the lump-sum payment) using that year’s income.
Then, you subtract any taxable benefits for that year that you previously reported.
The remainder is the taxable part of the lump-sum payment.
This amount is added to the taxable part of your benefits for the current year (calculated without the lump-sum payments that have been reassigned to previous years).
For example, if you received a lump sum back payment covering several prior years, you would:
- Calculate the Taxable Amount for Each Year: Determine the taxable amount for each year covered by the back pay benefits, using that year’s income.
- Subtract Previously Reported Taxable Benefits: Subtract any taxable benefits for those years that you previously reported.
- Add to Current Year’s Taxable Benefits: Add the remaining taxable amount to the taxable part of your benefits for the current year.
By using the lump-sum election method, you can avoid paying taxes on a large lump sum in a single year and instead spread the income over the years it was intended to cover.
This can help minimize your tax liability and ensure you keep more of the benefits you’ve been given.
For detailed instructions and worksheets, refer to IRS Publication 915: Social Security and Equivalent Railroad Retirement Benefits.
It is also recommended to consult with a tax professional or use tax preparation software to ensure accurate calculations and compliance with tax regulations.
If you or a loved one have received a lump sum back payment of SSDI benefits and need help addressing the tax implications, you can use the chat on this page to connect with a knowledgeable SSDI attorney.
Our team offers a free, no-obligation consultation and is available to answer any questions you may have about using the lump-sum election method to minimize your tax liability and maximize your benefits.