A section 86(e) election, also known as a “lump sum” election, is a way to reduce the amount of retroactive social security benefits included in your current year income.
Under section 86 of the Internal Revenue code, part of your social security benefits can be taxable in the year you receive them. However, when some of the benefits are for a prior year, you have the option of using an alternative method of applying the standard formula – the section 86(e) election.
To apply the election, you figure out how much of the retroactive benefits to include in the current year by recomputing how much of those benefits would have been taxable in the year you should have actually received them.
Here’s how it works, according to IRS Publication 915:
• You refigure the taxable part of all your benefits for the earlier year (including the lump-sum payment) using that year’s income.
• You subtract any taxable benefits you previously reported.
• The remainder is the taxable part of the lump-sum payment. Add it to the taxable part of your benefits for the current year (figured without the lump-sum payment for the earlier year).
Note there’s no need to file an amended return for the prior years, and there’s no formal election form or statement. You indicate you’ve chosen the section 86(e) election by writing “LSE” next to the line on your current year tax return that shows how much of your benefits are taxable.
The election is irrevocable without IRS consent, and can only be used when it lowers current year taxable benefits.