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Whether You Owe Taxes on Disability Payments Depends on Who Pays Premiums


Q: I received state disability insurance payments last year and became very confused in April when I filed my taxes. The state

told me that the payments were not taxable; the Internal Revenue Service said they were. I paid taxes on the payments but wonder if I did the right thing. It seems to me this is an issue that should be of great significance to lots of taxpayers.



A: The IRS says that whether disability payments are taxable depends on who pays the disability insurance premiums: the employer or the employee. If the employer pays the premium, or a part of it, the payments are taxable to the recipient up to the pro-rata share of the employer's portion of the premium. If the employee pays the premium or any part of it, the disability payments are tax-free up to that portion.

In California, generally speaking, employees are responsible for paying state disability insurance premiums. (This year, Californians will pay the tax on the first $31,767 of their earnings.)

Los Angeles Times Sunday June 22, 1997 Home Edition Business Part D Page 3 Financial Desk 3 inches; 78 words Type of Material: Correction; Column
Note: A recent column item regarding the waiver of penalties for early withdrawals from tax-sheltered retirement accounts contained an error. The 10% penalty for withdrawals made by taxpayers older than 55 who have been separated from their jobs is waived only for withdrawals made from what the Internal Revenue Service calls "qualified" profit-sharing plans. These include 401(k) plans and many, but not all, 403(b) plans. The penalty is not waived for withdrawals from IRAs, even if the IRA funds were originally transferred there from a 401(k) account.

There is one exception: When a taxpayer receives disability insurance payments in lieu of unemployment insurance, the federal government will tax the disability payments up to the maximum amount the recipient was eligible to receive in unemployment insurance. However, in this case, the state does not tax the payments because the state does not tax unemployment benefits, either.

So if you've paid tax on disability payments, you should immediately file an amended federal tax return to claim the refund you are due.


Q: I am 56 years old and about to take an early retirement. May I put the lump-sum distribution from my pension plan into an individual retirement account and immediately begin drawing an annual disbursement without penalty, just as if I were age 59 1/2?



A: The Internal Revenue Service waives the 10% penalty for IRA withdrawals for taxpayers over age 55 who have been "separated" from their jobs. (Beginning this year through 1999, Congress is waiving the 15% tax on excess distributions taken from a pension plan, such as a 401(k), should you decide to take the entire lump-sum distribution at once rather than rolling it over into an IRA.)

Taxpayers under age 55 may avoid the 10% penalty if they take equal annual IRA disbursements calculated according to life expectancy tables for their age group.

To calculate your annual disbursement, divide the total balance in all your IRA accounts by your life expectancy--or, if you want, your life expectancy and that of your IRA beneficiary or beneficiaries. These payments must continue at this rate for five years or until you reach age 59 1/2, whichever takes longer.


Q: It seems as though the rates on discount brokers' margin accounts are better deals than some home mortgages. May I borrow money from my brokerage margin account to make improvements to my home or buy a new house and deduct the interest charges as investment interest or mortgage interest?



A: You may claim neither deduction.

You can't deduct the interest as investment interest, because you are using the borrowed money to improve your home, not to make an investment.

Furthermore, you can't deduct the interest as home mortgage interest because the loan is not secured by your home.


Q: I am a Social Security recipient and work part time. Social Security taxes are deducted from my earnings. Should I have to pay Social Security when I am already collecting it?



A: All taxpayers, regardless of their age or whether they are drawing Social Security benefits, are subject to taxation on that portion of their earnings covered by the Social Security assessment. In 1997, Social Security taxes, at the rate of 6.2%, are levied on the first $65,400 of earnings. The Medicare tax of 1.45% is levied on all earnings. Please do not confuse Social Security and Medicare taxes with other features of federal law affecting Social Security recipients, namely the limit on earnings for Social Security recipients before benefits are reduced, which affects only recipients who continue to receive earned income.

There's also the portion of Social Security benefits subject to income tax, which depends on a recipient's total family income.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to

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