With tax season approaching, recipients of lump sum back benefits need to pay special attention to how they report their back benefits to the IRS.
The Basic Rules: Up to 50% of Social Security benefits are taxable if total “provisional income” (adjusted gross income, 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. For most people, this is all they need to worry about, but there are additional rules for higher earners.
The average monthly SSDI benefit for 2011 was approximately $1,072.96 or $12,875.54 for the year. As a result, many people relying on SSDI should not owe taxes. A problem can occur, however, if they mistakenly report all of a lump-sum payment received in 2011 as 2011 income, in which case they could end up paying too much in taxes.
The IRS allows taxes on SSDI lump-sum payments to be spread over previous tax years using the current-year tax return.
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. Also, the election removes the need to amend prior tax returns.
Make sure that you — or your tax preparer — understand how to report SSDI lump-sum payments.
Source: http://www.nosscr.org/tax.html