How to Deduct SDI on Schedule A

By Markets Fool.com

Workers are generally entitled to disability benefits under Social Security if their wages are subject to Social Security payroll tax withholding. However, some states also have disability insurance funds of their own, and they can impose their own contribution requirements for state disability insurance, or SDI, on workers within the state. If you live in the states that impose these requirements, which include California, New Jersey, New York, Rhode Island, and Washington, then you might be able to deduct the contributions on your federal tax return. Below, we'll go through the requirements to help you figure out whether you qualify for a tax deduction.

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A tax by any other name
It's not immediately obvious how to deduct the amounts you pay for state disability insurance contributions. However, the instructions for Schedule A to IRS Form 1040 specifically tell you how to treat contributions to the nonoccupational disability benefit funds of California, New Jersey, and New York, as well as the Rhode Island Temporary Disability Benefit Fund and the Washington State Supplemental Workmen's Compensation Fund. You'll find mentions of those programs under Line 5 of Schedule A, which covers state and local taxes. In other words, even though the states generally refer to money paid to these programs as contributions, the IRS simply treats it like any other tax.

Accordingly, the proper way to account for the deduction is to include it with any other state and local income taxes you owe. Note that if you choose to deduct sales taxes rather than income taxes, then you won't be eligible to include these SDI payments as deductions.

Limits on deductibility
Note that the way that the IRS requires you to handle SDI payments means that you won't always be able to take advantage of the deduction. If you don't have enough itemized deductions to exceed your standard deduction, then you'll be better off simply taking the standard deduction, and you'll lose any incremental benefit from deducting SDI payments.

In addition, state and local taxes are generally not deductible for those who are subject to alternative minimum tax. Therefore, if you're already in the AMT regimen, then additional deductions for SDI won't do you any good, because it won't be deductible for AMT purposes.

Nevertheless, many taxpayers will be able to deduct their SDI payments on their taxes. The benefit won't wipe out the cost, but it will offset it somewhat by producing some tax savings.

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