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Do I have to pay tax on my SSDI overpayment if I already paid tax on the disability insurance benefits for the same period of time?

As disability insurance attorneys we are not qualified to give any tax advice. Some disability claimants are taxed on the disability benefits that they receive each month. What happens when a disability claimant is approved for SSDI and then the disability carrier demands a repayment for the gross pre-tax disability benefits that have already been taxed? In this scenario the claimant is now being faced with having already paid tax on the disability insurance benefits and having to pay tax on the SSDI benefits as well.

We reached out to Gary Kaplan, a certified public accountant to provide some general information on this issue. If you have specific tax questions we suggest you contact an accountant.

Issue

Is there any tax relief for repayment of previously taxed disability payments?

Hypothetical Facts

Mr. Samson received monthly long-term disability benefits for 2.5 years (July 2008 – December 2010). Since he originally paid disability insurance premiums with pre-tax dollars, Mr. Samson’s disability benefits were taxable in the 3 prior years when he received the money. On January 1, 2011, Mr. Samson was finally awarded retroactive Social Security benefits for the 2.5 prior years. He is now required to pay the gross amount (i.e. before-tax) of disability benefits back to the disability insurance company, even though he already paid tax on those benefits.

Law And Analysis

Under Section 1341 of the Internal Revenue Code, if an item was included in gross income for a prior taxable year (years) because it appeared that the taxpayer had an unrestricted right to such item, a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item.

Tax treatment will occur in the tax year of repayment, and will depend on the amount repaid.

A. Repayment of $3,000 or less: The taxpayer must deduct the gross amount of disability income repaid in the current year as a miscellaneous itemized deduction on Schedule A, subject to the 2% of Adjusted Gross Income (AGI) limitation. Note that if the taxpayer does not itemize, or the repayment is less than 2% of AGI, there will be NO relief for taxes paid in any prior year.

B. Repayment over $3,000: There are two options available that can be used. One must compare the effects of treatment in both options; the taxpayer can use the one that results in the least overall tax effect:

  1. Current year treatment: Deduct the gross amount of disability income repaid in the current year as a miscellaneous itemized deduction, as described in (A) above.
  2. Prior year treatment: Recompute the tax for each prior year as if the disability income had not been reported that year. The difference between the recomputed tax and the actual tax can be claimed as a tax credit on the current year’s 1040.

Example:
Mr. Samson repaid $15,000 in 2011 that he previously included as income on his 2008 – 2010 income tax returns. He figures what his tax benefit would be under each available option:

  1. A 2011 miscellaneous itemized deduction: Net tax benefit = $3,400.
  2. The sum of credits for 2008, 2009 & 2010 recomputed income tax if disability income payments received were not included in taxable income in each respective years: Net tax benefit = $3,750.

Mr. Samson would choose option 2, which has the greater net tax benefit. He would enter $3,750 as a tax credit on his 1040 return for 2011.

Conclusion

Taxpayers who repay over $3,000 previously tax gross disability income can recoup up to all prior tax paid, depending if an itemized deduction or a credit for prior year taxes will result in the least amount of tax in the current year. Taxpayers repaying $3,000 or less in the current tax year can only recoup any prior tax paid if they itemize and the repayment is more than 2% of AGI.

This case study does not consider the tax treatment of Social Security disability payments, or other issues that may affect your particular situation. Tax planning for disability payments and other complex issues should be made with the help of an experienced tax professional.

If you have specific questions about tax issues related to disability insurance, Gary Kaplan can be reached at 866-643-3560 or by visiting his website at gkaplancpa.com.

There are 10 opinions so far. Add your comment now.

Mrs. E.B. Huber:

How is this impacted when you also receive a Workers Compensation settlement in the same year, prior to SSDI approval. The law states I cannot file a tax return if I am receiving Workers Compensation wages. Does that mean I have no shot at recouping the taxes I already paid in receiving my LTD when SSDI retro is issued for same period? Thank you.

Attorney Greg Dell:

E.B.,

You have asked a complicated question which needs to be answered by an accountant. I hope you can get some money back.

Sue Mills:

I believe I am subject to the windfall effect on my social security benefits as I will be eligible for a pension in which I did not pay into social security. I worked at a public school system in Ohio and they have their own state teachers retirement. I did work at a job prior and after those 13 years paying into soc. sec. for 20 years. Just recently qualifying for soc. sec. disability, I received a lump sum in which the windfall effect was not included. Is this because I have not applied for the pension from Ohio as I am not of age yet? My lump sum will repay long term disability. Also, is my soc. sec. taxable because I paid the premium post tax?

Attorney Greg Dell:

Sue,

Unfortunately, I am unable to answer your questions as Social Security Disability and its effects on Pension benefits is outside the scope of our focus. With respect to any questions you have as to the SSDI benefit I would advise you to consult with a SSDI attorney and with an accountant as it relates to any taxability.

Raymond:

We are experiencing this unfortunate situation, having received the back pay from SSD in late December, and paying back the LTD company early in the year, with the added whammy of two children in college.

The LTD company is still calculating the amount we need to pay back to them, meanwhile it is going to mess with the FASFA returns for our college kids (both of them).

I am wishing that we could repay the LTD company for last year, so things could “wash out” a lot neater and have less of an impact on my children’s financial aid…

Any suggestions?

Attorney Stephen Jessup:

Raymond,

Unfortunately, I do not have any suggestions as to the best way to handle your predicament outside of contacting your carrier to inquire.

Adam:

I received an overpayment statement that SSDI from 2013. The statement date was 12-26-2013 and I received it after the new year. I made the payment in full weeks later, 2014. Can I still apply this payment to my 2013 taxes? The amount was less than $3000.00.

Attorney Stephen Jessup:

Adam,

You will need to consult with an accountant or other tax professional as to your inquiry.

Linda:

I collected SSDI for 8 years and decided I couldn’t afford to live on this alone. I got a full time job, notified social security numerous times but they continued to send me monthly checks. Of course I spent them because I had read that social security will continue to pay for nine months after returning to work. They finally stopped after receiving 20,000.00+. I believe that year my taxes were affected. I am paying back at 50.00 a month, can I get any tax deduction for this?

Attorney Stephen Jessup:

Linda,

You will need to consult with a tax professional/accountant as to the tax ramifications. Additionally, you may want to consult with a Social Security attorney as to the repayment/overpayment.

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