Georgia State College of Law - College of Law



Appeal of proposed deficiency

Social Security Lump Sum payment

Submitted by:

Student’s Name, Student Attorney

Georgia State University College of Law

Philip C. Cook Low-Income Taxpayer Clinic

P.O. Box 4037, Atlanta, GA 30302-4037

Ph. (404) 413-9230

Fax (404) 413-9229

e-mail: taxclinic@gsulaw.gsu.edu

TABLE OF CONTENTS

List of Exhibits………………………………………………………………….......3

Relief Requested 4

Procedural Background Of Tax Matter………………………………………….4

Statement Of Facts 4

Applicable Law 5

Application Of The Law To The Facts.............................................................6

Conclusion……………………………………………………………….…………7

EXHIBITS

Exhibit A – Power of Attorney

Exhibit B – 2008 Tax Return

Exhibit C – 2008 IRS Account Transcript

Exhibit D – Notice of Deficiency

Exhibit E – US Tax Court Petition

Exhibit F – US Tax Court Answer

Exhibit G – Client’s letter with receipts of payments

Exhibit H – 2008 Wage and Income Transcript

Appeal of proposed defeciency

Relief Requested

TAXPAYER’S NAME respectfully requests the Internal Revenue Service (“IRS”) to remove her accuracy related penalty and recompute her tax due for Tax Year 2008. The IRS computed the taxable portion of a lump-sum Social Security payment based on Ms. TAXPAYER’s 2008 income instead of the income for the three prior years to which the payment was partially allocated, an alternative method provided by Code section 86(e).

Procedural Background of Tax Matter

Ms. TAXPAYER filed a timely return for tax year 2008 in which she owed $431. [See Exhibit B, the 2008 tax return.] The check for $431 that she sent in with her return was returned for insufficient funds. She sent in a new check for $489.12 which covered all fees for late payment, bad check, and interest, and brought her account balance to $0. [See Exhibit C, 2008 IRS Account Transcript.]

Ms. TAXPAYER received a Notice of Deficiency from the IRS dated November 8, 2010. [See Exhibit D, Notice of Deficiency.] The notice indicated that Ms. TAXPAYER did not report $73,342 in Social Security benefits and her tax was increased to $12,248. In addition, an Accuracy-Related Penalty of $2,450 was imposed, along with interest of $811. The total amount due is $15,509.

Ms. TAXPAYER filed a timely petition with the United States Tax Court disputing the deficiency on November 24, 2010. [See Exhibit E, US Tax Court Petition.] Ms. TAXPAYER ’s petition was answered by Counsel on January 21, 2011. [See Exhibit F, Answer.] Ms. TAXPAYER sought assistance from the Philip C. Cook Low-Income Taxpayer Clinic on January 28, 2011. [See Exhibit A, Power of Attorney Form 2848.]

Jurisdiction currently lies with Appeals.

STATEMENT OF FACTS

Ms. TAXPAYER has been permanently disabled since 2004. Ms. TAXPAYER ’s employer had a voluntary long-term disability insurance plan for employees, whereby employees could elect long-term disability insurance coverage at a group rate and pay for it through salary reduction. Ms. TAXPAYER participated in this plan. Because Ms. TAXPAYER paid the premiums for the insurance with after-tax money, the benefits were to be provided to her tax-free. The disability insurance plan had a Social Security offset rider which provided that the disability carrier would reduce the benefit paid by any amount of Social Security disability benefit received by the insured. Furthermore, the insurer would provide representation to the insured to seek Social Security disability benefits.

In 2005, Ms. TAXPAYER’s initial application for Social Security disability benefits was denied. The disability insurance company’s lawyers continued to appeal the decision on Ms. TAXPAYER ’s behalf. Ultimately, the insurer was successful in obtaining Social Security benefits for Ms. TAXPAYER in 2008. In 2008, Social Security paid Ms. TAXPAYER a lump-sum distribution of $73,342 for the benefits she should have received in 2005, 2006, and 2007 if her initial application had been accepted, in addition to her 2008 disability benefit. [See Exhibit H, 2008 Wage and Income Transcript.] Of the $73,342 of Social Security disability payments Ms. TAXPAYER received, $21,712 was allocated to 2008 benefits, $21,216 was allocated to 2007, $20,544 was allocated to 2006, and $9,870 was allocated to 2005.

As required by contract, Ms. TAXPAYER reimbursed the insurer for $51,408 of benefits that they had already paid her. [See Exhibit H, Client’s letter with Receipts of payments.]

Ms. TAXPAYER incorrectly assumed that her Social Security disability benefit was not taxable because her private disability insurance payments had not been taxable and she had a contractual obligation to reimburse the insurer with her Social Security disability payment.

Applicable Law

Code section 1 imposes a tax on “taxable income.” Taxable income is the taxpayer’s gross income, as defined in section 61 and elsewhere in the Code, less deductions provided by law. I.R.C. § 63. Section 86(a) expands the definition of gross income to include a portion of the Social Security benefits received by the taxpayer, based on a formula provided in the subsection. Generally, the benefits are included in gross income in the year they are received.

Because some payments include benefits for an earlier year, section 86(e) provides taxpayers receiving a lump-sum distribution with an election that may limit the amount included in gross income. see Pollard v. Commissioner, 2011 T.C. Memo 132 (“The election … provides an alternative method of applying the formula to determine the taxable portion of the Social Security benefits.”)

Section 86(e) was added to the Code in 1983. P.L. No. 98-21, § 121(a), April 20, 1983. The statutory language reads:

LIMITATION ON AMOUNT INCLUDED WHERE TAXPAYER RECEIVES LUMP-SUM PAYMENT. –

(1) LIMITATION. –If–

(A) Any portion of a lump-sum payment of Social Security benefits received during the taxable year is attributable to prior taxable years, and

(B) The taxpayer makes an election under this subsection for the taxable year,

then the amount included in gross income under this section for the taxable year by reason of the receipt of such portion shall not exceed the sum of the increase in gross income under this chapter for prior taxable years which would result solely from taking into account such portion in the taxable years to which it is attributable.

(2) SPECIAL RULES. –

(A) YEAR TO WHICH BENEFIT ATTRIBUTABLE. – For purposes of this subsection, a Social Security benefit is attributable to a taxable year if the generally applicable payment date for such benefit occurred during such taxable year.

(B) ELECTION. – An election under this subsection shall be made at such time and in such manner as the Secretary shall by regulations prescribe. Such election, once made, may be revoked only with the consent of the Secretary.

The Secretary has not prescribed by regulation the time or manner in which an election under this subsection shall be made.

When making the election, the taxpayer calculates the sum of increases in gross income for any prior years to which the distribution would has been allocated. Only this sum is included in the taxpayer’s gross income for the current year. No increases are made for the prior year. I.R.C. § 86(e). In applying the election, the court has held that the election must be to the benefit of the taxpayer, and the taxpayer must have reported the benefits on the tax return for the year they received the distribution. Pollard. To determine if the election is to the benefit of the taxpayer, the court will examine the returns of any previous years to which the distribution is allocated. Id. The court has also held that an election made at the time of trial is not timely. Brady v. Commissioner, 2013 T.C. Memo 1.

APPLICATION OF LAW TO FACTS

In 2008, Ms. TAXPAYER received a lump-sum payment of Social Security benefits. A substantial portion of the payment covered benefits that she would have received had her initial claim for benefits been awarded. This portion of the payment is attributable to prior taxable years. Specifically, $9,870 is attributable to Tax Year 2005, $20,544 is attributable to Tax Year 2006, $21,216 is attributable to Tax Year 2007, and $21,712 is attributable to Tax Year 2008.

The election provided in IRC § 86(e) allows Ms. TAXPAYER to compute the taxable portion of her Social Security disability lump-sum payment based on the increase in gross income for the tax years to which the payment is allocated. She is entitled to make the election if it is to her tax benefit.

Conclusion

Ms. TAXPAYER respectfully requests that the Internal Revenue Service recompute her 2008 tax liability in accordance with her desire to make an IRC § 86(e) election. She further requests the removal of the accuracy related penalty for Tax Year 2008, based on the recomputed tax liability,

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