Since disability benefits through Social Security are considered income, they are subject to taxation. How your benefits are taxed depends on the kinds of benefits you receive and how much other income you have.
As an initial matter, Supplemental Security Income (SSI) payments are not taxed. SSI is a needs-based program provided to no- and low-income individuals who, by definition, do not have sufficient income to reach the threshold for taxation. SSI recipients also have limited, if any, assets.
On the other hand, Social Security Disability Insurance (SSDI) may be subject to tax if you are also receiving income from other sources or, if you are married, your spouse is receiving other income. Other income includes interest payments and dividends from stocks.
If you are single, and you have over $25,000 (including half your SSDI benefits) in income per year, a portion of your SSDI benefits will be subject to tax. If you are married and filing jointly, and you and your spouse have over $32,000 (including half your SSDI benefits) in income per year, a portion of your SSDI benefits will be subject to tax.
The rate at which your SSDI benefits will be taxed depends on how much income you receive each month and whether you are married. If you are single, 0% of your benefits will be taxed if your income is between $0 and $2,083, 50% of your benefits will be taxed if your income is between $2,084 and $2,833, and 85% of your benefits will be taxed if your income is $2,834 or higher.
If you are married, 0% of your benefits will be taxed if your income is between $0 and $2,666, 50% of your benefits will be taxed if your income is between $2,667 and $3,666, and 85% of your benefits will be taxed if your income is $3,667 or higher.
Most states do not tax SSDI benefits, but the following states do in certain situations: Colorado; Connecticut; Kansas; Minnesota; Missouri; Montana; Nebraska; New Mexico; North Dakota; Rhode Island; Utah; Vermont; and West Virginia (West Virginia intends to phase out taxation by 2022). Check with your local Social Security Administration (SSA) to see if you live in a state that may tax your SSDI benefits.
Should your disability benefits be subject to taxation, they will be taxed at your marginal income tax rate. But even if your benefits are not subject to tax, they still must be reported on your tax return.
If you receive a one-time, lump-sum payment for back benefits, it might bump your income for the year in which you receive it, forcing you to pay a larger amount of your back pay in taxes. To avoid this scenario, talk to your attorney, an accountant, or tax preparer for assistance. You are allowed to amend tax returns from prior years to reflect the income you would have received.