When it comes to taxes, disability benefits payments can be very confusing. There are so many different rules applying to different forms of payments and different portions of the payment and different people that it’s hard to know what applies to you and your particular disability benefit. The key is to break your total benefit into each of its different components and each of its components into their different elements. Then you can see what tax rules apply to each of the parts given your age.
If you don’t know what a disability benefit payment is, this article probably isn’t for you, but just to clarify it’s a payment you get from the Department of Human Services if you have physical or mental illness that two physicians certify makes it impossible for you to be gainfully employed in a position for which you are otherwise qualified.
In order to claim the payments, you must go through the Department of Human Services – you cannot claim them through the ATO. But when you file your tax return with the agency, you may be required to report some of your payments as assessable income and even pay tax on them. Here’s how to tell how much you’ll owe.
The sum of its parts
The key to understanding how these benefits are taxed is to break them down. First of all, your disability payments can be broken into a tax-free component and a taxable component.
The tax-free component is just that: tax-free. You don’t have to declare it on your tax return and it is not considered assessable income.
The taxable component, however, is a different story and can itself be divided into a taxed element and an untaxed element.
Here’s where things get a little more complicated. The taxed element has already had tax paid on it, but depending on your age you may have to pay even more and include it on your return as assessable income.
The untaxed element definitely hasn’t had any tax paid on it, which means that you will have to pay tax on it and declare it on your return.
There are different rules governing these two elements that depend on your age as well as how you receive your payments. If you receive them as a lump sum, read on. If you receive them as an income stream, skip to the relevant section.
Disability payments received as a lump sum
You will owe the following on the taxed element of your payments depending on your age:
- 60 and over – You don’t owe tax
- At or above preservation age but below 60 – You don’t owe any tax up to the low-rate cap amount of $165,000 for 2011-2012 or $175,000 for 2012-2013. Beyond the cap you will be taxed at 15%.
- Under preservation age – You will be taxed up to 20%.
And here’s what happens to the untaxed element:
- 60 and over – You will be taxed at 15% up to the untaxed plan cap of $1.205 million for 2011-2012 and $1.255 million for 2012-2013. Beyond that it is taxed at your top marginal rate.
- At or above preservation age but below 60 – You will be taxed at 15% up to the low-rate cap amount of $165,000 for 2011-2012 and $175,000 for 2012-2013. Above this cap, you will be taxed at 30% until the untaxed plan cap amount of $1.205 million for 2011-2012 and $1.255 million for 2012-2013. Above this cap benefits are taxed at the top marginal rate.
- Under preservation age – You will be taxed at 30% up to the untaxed plan cap amount of $1.205 million for 2011-2012 and $1.255 million for 2012-2013. Beyond this they are taxed at the top marginal rate.
Disability payments received as an income stream
You will owe the following on the taxed element of your payments depending on your age:
- 60 and over – No tax payable.
- Under 60 – You will be taxed at your marginal rate and you will get a tax offset amounting to 15% of your income stream’s taxable component.
You will owe the following on the untaxed element of your payments, depending on your age:
- 60 and over – You will be taxed at your marginal tax rate and you will receive a tax offset amounting to 10% of the untaxed element.
- Under 60 – You will be taxed at your marginal rate. There is no tax offset for the untaxed element.
What do I have to declare on my tax return?
You don’t have to include any of the tax-free component of your disability payments on your tax return.
But if you have a taxable component, you will have to declare it. You will receive a payment summary that outlines your taxable component as well as any offsets you are eligible to claim.