New Bill Would Help Social Security Lump-Sum Recipients Avoid Tax Hit

New legislation, the Fairness in Social Security Act, would prevent Social Security Disability Insurance recipients from being hit with a stiff tax bill when receiving a retroactive lump-sum payment when their benefits start.

Disabled beneficiaries must “satisfy a waiting period of several months before benefits start, but they receive a lump sum retroactive to the date of being found eligible for benefits,” Mary Johnson, Social Security and Medicare policy analyst for The Senior Citizens League, explained. “Retirees can also choose to file a claim for up to six months in retroactive benefits when they first apply for benefits.”

In both cases, Johnson told ThinkAdvisor Wednesday in an email, “the eligibility date for the lump sum could apply to the prior tax year, but the money might not be received until the next year when apparently it is added into current benefits for tax purposes.”

This bump in income “can trigger large tax liabilities, and result in the reduction or elimination of premium assistance” under the Affordable Care Act, According to Max Richtman, president and CEO of the National Committee to Preserve Social Security and Medicare.

The Fairness in Social Security Act, introduced in late June by Rep. Joe Neguse, D-Colo., “would remove the inclusion of Social Security Disability Insurance payments prior to the current tax year when calculating an individual’s income — to ensure these individuals are not left owing large sums back to the Internal Revenue Service,” Richtman said.

Flexibility, Not Tax Dodging

Johnson said that the bill “appears straightforward and a reasonable proposal, that would not necessarily affect funding levels in the Social Security Trust Fund at all.”

Neguse’s bill “would allow the recipient to select to include [the lump-sum payment] in the prior year. That’s not going to dodge taxes,” Johnson explained. “One would still owe any tax due based on the prior-year calculations, but it might be more advantageous if one’s income was lower in the prior year, which it probably would be because benefits were received over fewer months.

“I think this flexibility would especially help lower- to middle-income beneficiaries and would likely be supported by most Social Security beneficiaries.”