Tax Talk With Jim

By James A. Horchak, Esq., C.P.A.

We are often asked by our clients whether Social Security benefits are taxable. For Pennsylvania state tax purposes, the answer is simple - Social Security is not taxable.

It gets a little complicated when looking at how the Internal Revenue Service treats Social Security income for federal tax purposes. First of all, Supplemental Security Income benefits are not taxable for IRS purposes. However, Social Security Disability or retirement benefits are looked at differently. If you and/or your spouse receive only Social Security disability or retirement benefits, these benefits are not taxable by the IRS. If you or your spouse have other taxable income, the answer is not as simple. For example, in 2008, if you and your spouse had income over $32,000 (or $25,000 for individuals), then 50% to 85% of your Social Security benefits could have been taxed.

All individuals who receive Social Security benefits will receive Form SSA-1099-Social Security Benefits Statement. This statement lists your net benefits in Box 5 and it is this figure that is used to determine whether your Social Security benefits are taxed.

Your Social Security tax questions may be more complicated if you are also receiving workers' compensation benefits. The law provides that Social Security Disability benefits are reduced - or "offset" - when a worker is also receiving workers' compensation benefits. This means that you will receive your full workers' compensation check and reduced Social Security Disability benefits. Even though workers' compensation benefits are not taxable by the IRS or Pennsylvania, you may be required to pay federal tax on the full amount of Social Security benefits you are entitled to receive - even if part of that amount is actually received from a workers' compensation carrier.

Another impact on your tax situation occurs if you are issued a lump sum check for Social Security disability benefits. Because these benefits are retroactive and may span two or more years, the Internal Revenue Code allows taxpayers to calculate their taxes using one of two methods and pay the tax on the method that results in the least amount of tax due. The first method is to calculate the tax reporting the full lump sum on the current year's return. The second method involves calculating the tax due by allocating the lump sum to the appropriate tax year.

You may be able to deduct legal fees you pay in connection with an award of Social Security benefits as a miscellaneous itemized deduction. This deduction only applies to those taxpayers who benefit from itemizing their deductions rather than taking the standard deduction.