Are your clients overpaying taxes on SSDI income?

Los Angeles, CA - A couple of weeks ago, in a breakfast meeting session of the San Fernando Valley Chapter of the California Association of Enrolled Agents, a question came up about how to handle the taxes on a lump sum payment of Social Security Disability Income (SSDI).

As we all know, folks who apply early for Social Security benefits because they have become disabled, generally get turned down the first time. And the second. And the third. Often, it’s as if the Social Security Administration is in collusion with the legal profession, not granting benefits until an attorney has been hire – regardless of how ill, or even close to death, the applicant may be.

When they finally do get approved for SSDI benefits, the benefit is approved, retroactive to when they first filed, which could mean 3 or 4 years benefits all at once.

As we also know, had they gotten SS benefits all along, most likely, none of the benefits would have been taxed. But getting a big chunk like that takes their MAGI (modified adjusted gross income, including SS benefits) over the $25,000 or $32,000 exclusion for Social Security benefits.

And true, we also know there is a special calculation to deal with this, by making a lump-sum election. This definitely can reduce the taxes due.

BUT…is SSDI taxable at all?

The question came up, and TaxMama® started investigating. What if SSDI benefits come from the Supplemental Security Income fund (SSI)? SSI benefits are not taxable.

Publication 915 alerts you:
Supplemental security income (SSI) payments. Social security benefits do not include SSI payments, which are not taxable. Do not include these payments in your income.

Since the disability benefits are coming to you early, are they drawn from the regular SS fund? Or do they come from SSI fund? No one seems to have looked into this question.

So TaxMama® posed it to the IRS. The question got passed around a few times to various staff members in the Washington, DC offices. Until it finally came to one person who was able to get a definitive answer. This fellow from the IRS’s DC Press Corps is generally one of the more delightful and helpful folks there. He was utterly surprised to learn that SSDI benefits come from the SSI fund – and are therefore not taxable income at all!

All these years, we’ve been overtaxing our clients by taxing their lump sum benefits - and adding their SSDI income to their regular taxable income.

It’s time to go and amend all those tax returns. Well, at least for the open years…

Just think, what a hero you’re going to be, getting your clients back all those refunds!

Unfortunately my friends, this is an April Fool’s joke.
Everything in this article is true, except the final conclusion. I really did do some digging, since it did seem plausible. Eric Smith at the IRS press office, did verify that SSDI benefits come from the regular fund and are taxable as if they were regular Social Security benefits.