taxes

Taxes on Social Security disability income

Judy O'ConnorDear Tax Talk,
I applied for disability on Nov. 4, 2012. I've now received notice back from Social Security that, yes, I'm a disabled person. Circa March 2013, I started receiving monthly payments from Social Security. Social Security also indicated and determined that I would also receive a "lump sum" payment for my ongoing issues based (I believe) on my first hospital visit in August 2010. This is when I was first diagnosed at my primary care physician's office and also the local hospital's emergency room.

Also, my wife is working at our local elementary school full time/part time. By this I mean 30 hours per week.

My questions are:

  1. Are taxes due on the lump sum payment? Note: This time period might actually be from Aug. 2011 till present. How would prior-year tax returns be affected?
  2. Are taxes due on the monthly payments I receive? If so, how are they shown (i.e., W-2, another tax form, etc.)?
  3. Currently, I'm also paying into my former company's health plan. Additionally, as of Oct. 1, 2013, I'm automatically receiving Medicare Parts A and B. Also, I'm signed up for paying a 10 percent reduction of Part B to Social Security toward any taxes on the monthly amount I receive.

    Yes, we do itemize, usually using TurboTax software.

  4. Also, are we eligible to set up an HSA? I understand that since I'm not working at this time, I'm not allowed to have a flexible spending account. What type of accounts might I use to fund an HSA? Could I use an IRA, money market, CDs, etc., to fund this potential new HSA account, yet also to best receive some tax benefits, etc.?

Thanks for taking the time to read and ponder the questions, and for any ideas to get taxes correctly finished, and if possible, minimized.
-- Michael

P.S. I've read a lot of your columns since I discovered your site. Keep up the great work!

Dear Michael,
First of all, I want to thank you for the positive feedback on the tax column.

As you now know, it takes a tremendous amount of patience, diligence and quite a lot of time to work through the bureaucracy of Social Security in order to get disability payments. Once again, it is going to take some work on your part to determine what taxes you may owe on your Social Security disability income.

After the end of each year, Social Security mails out Form SSA-1099 to tell you how much you received in benefits, as well as other information. Given your situation, they will tell you how much of the benefits were for prior years, how much has been deducted for Medicare and how much you have had withheld for federal taxes. In order for you to determine if any of the benefits are taxable, you are going to need Form SSA-1099 and to complete Worksheet A from page 3 of IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Your tax software should be able to do the calculation once you input all of your tax information.

As a general rule, you use each year's income to calculate the taxable portion of your total benefits received for that year. However, you can make the "lump sum election" and recalculate your taxes for each of the earlier years separately, using your income for each of the prior years involved. This election may result in lowering your taxes, but you are going to have to complete some more worksheets from Publication 915. Again, more time and effort on your part, but it could be beneficial to you. In your situation, you will need Worksheet 1, Worksheet 2 and Worksheet 4 for each earlier year that you received the lump-sum payment. Once you complete all of the worksheets, you will then need to compare the taxable benefits on line 19 of Worksheet 1 with the taxable benefits on line 21 of Worksheet 4. If the taxable benefits on line 21 of Worksheet 4 are lower than the taxable benefits on Worksheet 1, you can elect to report the lower amount on your return. If you are going to make the election, be sure to follow the instructions at the bottom of Worksheet 4.

Because you are enrolled in Medicare, you are not eligible for a Health Savings Account, or HSA. However, you may want to look into the Medicare Advantage Medical Savings Account, or MSA. You will need to have a high deductible health plan and be enrolled in Medicare. The federal Medicare program administers the Medicare Advantage MSAs. For additional information you can call 1-800-Medicare (1-800-633-4227) or go to Medicare.gov.

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