What are Social Security Disability Benefits
Social Security Disability benefits are a government program that provides financial assistance to disabled individuals who have worked for an extended period of time but are no longer able to do so due to their impairment. Disability benefits are designed to give beneficiaries peace of mind that they have the financial support they need while they continue on the difficult path to recovery. To qualify for Disability benefits, a person must demonstrate that their impairment keeps them from performing their job, or any similar work, and that this impairment is expected to last for at least a year.
Most often, Disability benefits will only be granted after a lengthy application process where the applicant has been required to submit extensive documentation of their impairment. If the insurance company believes that the applicant may not be telling the truth regarding their ability to work , it may request that the person undergoes a medical evaluation by a doctor chosen by the insurance company. In addition, the applicant’s medical and financial background will be investigated in depth.
Due to the extensive amount of information that will be required to support the application, it is not uncommon that a person will be denied Disability benefits the first time that they apply. Applicants have the ability to appeal their denial for Disability benefits, however, and fairly often these appeals are successful. Supplemental Security Income Disability is another type of Social Security Disability benefit that applies to people with limited financial resources who have a qualifying disability.
SSD and the Role of the Attorney
Social Security Disability clients are almost always represented by an attorney who specializes in disability. Disability is such an expansive topic that a dedicated attorney is the only person who may be able to gain you the benefits you need while assisting you with the complex legal representation they have become accustomed to completing with ease. Most often, when you are injured or ill, a large number of complicated forms will need to be completed. Sifting through all of those pages and getting all of the necessary information can seem a bit overwhelming. Once you have secured an attorney to assist you with your case, they will do their best to ensure that you understand what documents you will be required to fill out, with assistance, and submit with your claim for disability. They will also assist you in understanding what might be required of you as your case progresses. If there are questions about what has been requested by the social security department, your attorney can assist you in clarifying all of those questions. The costs of your attorney’s services, in most cases of social security disability representation, will be paid by the Social Security Administration when you case is won. Most clients will not be charged for the services provided by their attorney until they receive approval for disability.
The Taxability of Disability Attorney Fees
Like most things about taxes, the answer to whether attorney fees for Social Security Disability are deductible is complicated. Generally, most tax considerations have to do with "revenue neutral" issues, but legal fees are among those things that have exceptions to the rules.
Basically, the IRS wants to know:
1. Do the legal fees have to do with "Trade or Business" Income, and if not, for what type of income do the legal fees apply.
2. The deduction of legal fees (to the extent that they are allowed) are discussed in IRS publication 535 which we quote below.
Publication 535
Legal fees. Your legal fees incurred in connection with your trade or business are deductible. However, legal fees that are not connected with your trade or business may be deductible as explained in Deductible Expenses, later.
You can deduct all your legal fees if they were paid or incurred for:
• Your trade or business.
• Production or collection of income.
• Management, conservation, or maintenance of property held for producing income.
• Tax advice or any other kind of advice related to a business. (See item 9 under Miscellaneous not deductible, later.)
You cannot deduct legal fees or court costs if the origin of the claim arising from the fees was:
• Your personal life.
• Dispositions of property.
• Claims involving personal injuries.
• Claims that you made as a result of a personal loss.
Legal Fees Paid as a Result of Wages Not Lawsuit or Court Costs
If your employer reimburses you for legal fees, the expense is effectively wages and not necessarily deductible as noted next.
Taxable fringe benefit. Generally, legal fees that you are reimbursed for are a taxable fringe benefit. You must include the reimbursement in income in the year you receive it. You cannot deduct the fees, even if the reimbursement appears as a payment for legal fees on your Form W-2 in box 10. The qualified performing artists exception discussed later under Qualified Performing Artists in this chapter does not apply to this rule.
Tax Rule Specific to Disability Attorney Fees
Not only is the treatment of attorney fees earned in a Social Security Disability and/or Supplemental Security Income case different from the rules that govern attorney fees earned for other types of work (i.e. wages, business earnings), but the treatment is also different from most other "unreimbursed expenses" that a taxpayer might claim. This is due to the combination of two tax rules: the limitation on itemized deductions (adjusted gross income or "AGI" based) and the "2% floor" on miscellaneous itemized deductions.
As a general rule, there is no deduction allowed for hours spent up to the hearing on a Social Security Disability matter, which is treated as the injury itself, the cost of which cannot be deducted. However, hours spent at the hearing, or for a suit against a person/s or company, may be deducted.
A client may deduct legal fees paid to the Social Security attorney in 2017 if the fees are attributable to a contested matter. Fees will be considered attributable to a contested matter if all of the following apply:
- All legal services are paid for in the year you file your tax return.
- The taxpayer was required to pay the attorney directly.
- The attorney is not related to the taxpayer (unless the taxpayer can prove that the fees were for a contested matter).
- The taxpayer and related parties did not ask the other party to make the fee payment even though they were not required to do so.
- The taxpayer has sufficient records to substantiate the amount of the payment.
- The taxpayer is the named party in the determination.
The fee deduction is limited to the lesser of the fees actually paid or the net amount of cash received. Even though deductible, a taxpayer’s itemized deductions must exceed the applicable standard deduction before the SSA attorney fee can actually help you.
How to Deduct Attorney Fees Properly on Your Taxes
There is a general procedure that was recently told to me by a Social Security Disability tax attorney. This is the step by step process to deduct attorney fees from Social Security Disability claims on your personal taxes:
- As mentioned above, you pay the attorney for representation. When a client hires a Social Security Disability lawyer, they also sign a contingency fee agreement which gives the attorney permission to charge them 25% of their back payments when they receive a favorable decision.
- When it comes time to pay the attorney , Social Security cuts you a check for the total amount that they owe you and the amount that they owe the attorney.
- When you receive your check in the mail, you take a percentage of that check and write a check back to the attorney.
- The Social Security Administration will send you a 1099 that states the total amount paid to the attorney in Step 2, the amount you paid back in Step 3, and the difference between those two amounts, as well as an explanation of why the difference is not being deducted from your check.
Common Errors and Avoiding Mistakes
One of the most common mistakes people make when deducting attorney fees related to Social Security Disability is assuming that all kinds of legal fees are fully deductible. As mentioned above, legal fees incurred before an appeal is made for Social Security Disability or for securing a taxpayer’s right to collect an amount of underpaid tax are not deductible under any circumstances. It is also a mistake to assume that small amounts payed over time can simply be added up and treated as a single deduction. Taxpayers do not have to reach a particular monetary threshold before working with an attorney becomes deductible. Some taxpayers wrongly treat their legal fees as an unreimbursed employee expense. This is actually a common mistake employers make as well. In order to be deductible as an unreimbursed employee expense, the legal fees must be related to a transaction during the course of employment. An example of such employment would be if an employer asks an employee to sign a non-compete agreement and the employee hires an attorney to review the agreement. The cost of the review of the agreement would be a deductible unreimbursed employee expense since it was done for the purpose of furthering the employee’s job security. Without this exception, an employee who loses their job and is forced to try to collect unemployment benefits would not be able to deduct the cost of legal fees necessary to appeal the denial of the unemployment benefits. For taxpayers who do not have enough miscellaneous itemized deductions to meet the threshold, it may be worth it to add them to their return. A married couple filing jointly may not have enough miscellaneous itemized deductions to meet the 2% threshold if the attorney fees are not included. Individuals, married filing separately, and heads of household are subject to different thresholds which are generally lower than the 2% threshold for married couples filing jointly.
Seek Help from a Tax Professional
When it comes to tax laws and eligibility requirements, we think of the Social Security Administration (SSA) policies as similar to the IRS (Internal Revenue Service) policies. When it comes to Social Security Disability benefits, there are many ways that these 2 organizations can potentially affect your situation, but with taxes, you have an additional layer of legal involvement that you must consider. The SSA requires that you prove the extent of your disability, or your ability to work , while the IRS looks more to the amount of money you earn. There is no need to fret about being audited for disability exclusion of income because the SSA does not share any information with the IRS. When it comes to your income during disabled status, however, it is important that you consult with a tax professional. A tax professional can help you decide whether or not your attorney fees are deductible due to your disability status. They can also help you to manage your overall tax liability, especially if you receive disability benefits now. As long as you stay within your limits, most individuals benefit from obtaining a tax professional who can help them to save the most money through legal means.
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