Let’s get in the way-back machine and travel to 1941, when a treasury department tax ruling excluded social security benefits from being taxed on your federal income tax return.
Next we’ll skip to 1979, when the Advisory Council on Social Security concluded that the 1941 ruling was wrong and that the tax treatment of private pensions was a more appropriate model for tax treatment of social security benefits.
Next stop: 1981, when Senate Resolution 87 passed on a July 14 vote of 98-0 to express the sense of the senate that social security benefits should remain exempt from federal taxation.
Turn the machine’s dial to 1983 and the report of the National Commission on Social Security Reform (the Greenspan Commission). In the report, the commission recommended that social security benefits be taxable. That led to the social security amendments of 1983, making social security benefits partially taxable beginning in 1984.
Now ride the way-back machine to present day and disembark. Social security benefits are still taxable—sometimes in ways you might not expect.
In Docket Number 27994-14 (Pagan), the taxpayer received social security benefits of $3,540 during 2012 and reported them on her federal income tax return. She also received workers’ compensation of $22,406 that year. Those payments were a direct offset to her social security benefits, and the taxpayer did not report them on her return because she believed the payments were nontaxable. (Workers’ compensation is generally excludable from income under internal revenue code section 104(a)(1)).
The IRS said taxable social security benefits include the amount of the workers’ compensation payment to the extent that they reduce or offset the total social security benefits to which the recipient is entitled. (See internal revenue code section 86(d)(3).) Therefore, the IRS said $19,045 of the taxpayer’s workers’ compensation offset (85% of the total amount), was includable in taxable income as a social security benefit.
The taxpayer argued that she never actually received the $22,406 of the workers’ compensation offset. In addition, she produced an agreement she’d reached with the IRS in 2009 based on similar facts in which the IRS agreed to a settlement.
The tax court said it was not bound by the settlement agreement, and was instead “dutybound to apply the law as written by congress to the facts as they occurred.” Because the taxpayer’s social security benefits were reduced by the amount of workers’ compensation benefits received, the court agreed with the IRS that the offset amount was treated as a social security benefit and was taxable.
Did you know a workers’ compensation offset is treated as a social security benefit?
Here are a few other questions to test your knowledge of the taxability of social security benefits.
You had an attorney handle your social security claim. The fee was withheld from your benefits and paid directly to your attorney. Should you reduce the amount of your net social security benefits that you use to figure taxable social security (generally box 5 of Form SSA-1099, Statement of Social Security Benefits)?
To determine the amount of taxable social security benefits, you start with your adjusted gross income (not including social security benefits). Then you “modify” that amount by adding back certain items, such as tax-exempt interest you received or accrued during the year, exclusions for amounts paid under an adoption assistance program of your employer, and deductions for interest on qualified educational loans.
Is the exclusion for income on savings bonds that you use to pay higher education expenses an add-back when determining your modified adjusted gross income?
The income thresholds for determining how much of your social security benefits are taxable start at a base amount. The base amount is $25,000 when you file as single, head of household, or qualifying widow(er), or are married but filing separately from your spouse (if you have lived apart all year). If you’re married filing a joint return, the base amount is $32,000. If you’re married filing separately and you lived with your spouse at any point during the year, the base amount is $0.
Are these base amounts adjusted for inflation each year?
Up to 85% of your social security benefits can be taxed.
The proceeds from taxing social security at the 50% rate are credited to social security’s two trust funds—Old-Age and Survivors Insurance, and Disability Insurance. Where are proceeds from taxing benefits at higher rates credited to?
Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.
This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.