A recent U.S. tax court case highlights the frequently misunderstood lump-sum election for Social Security benefits.
The Section 86(e) election can help lower the taxes of individuals who receive a lump-sum benefits payment, however taxpayers often erroneously think that the existence of the election eliminates their obligation to report the lump-sum payment in the first place.
The case, Robbins v. C.I.R., (PDF) involves a Maryland couple who failed to report a $59,895 lump-sum Social Security disability payment on their 2014 return.
The couple contended that no portion of the $59,895 benefit was includible in gross income because, if they had instead received annual payments of $15,994, $18,940, and $24,961 as the benefits accrued during 2012–2014, no tax would have been due.
How the lump-sum election works
The mechanics of the Section 86 lump-sum election are described in IRS Publication 915. Generally, the taxable part of a lump-sum (e.g. retroactive) Social Security payment is includable in the tax year that the payment is received even if the payment includes benefits attributable to a prior year.
The Section 86(e) election allows a taxpayer to figure the taxable part of the lump-sum payment from an earlier year separately using the income from that earlier year.
If the lump-sum election is made, “the amount included in gross income for the taxable year of receipt must not exceed the sum of the increases in gross income for those previous taxable years that would result from taking into account the portion of the benefits attributable to the previous taxable years.” See Pollard v. C.I.R., T.C. Memo. 2011-13, 2011 WL 2436937 (June 14, 2011).
No Section 86 election without reporting income
In the Robbins case, the couple argued that they were not required to report the $59,895 lump-sum payment because they wouldn’t have had a tax bill if they received the benefit payments in the years that the benefits are attributed to.
In a memorandum decision, the tax court noted that the couple couldn’t have made the Section 86(e) election because they failed to report the Social Security benefits on their 2014 return at all. The IRS worksheets also determined that even if the taxpayers had made the election, they would have owed more than what was reflected in their notice of deficiency.
In an earlier case, Pollard v. C.I.R., the taxpayers similarly failed to report their Social Security benefits. The court in that case also noted that the taxpayers both failed to properly make the Section 86(e) election and failed to provide income numbers for the years at issue, so it was impossible for the court to tell whether the election would have benefited them.
Robbins v. C.I.R., T.C. Memo. 2017-247, 2017 WL 6501921 (Dec. 18, 2017) (PDF)
Pollard v. C.I.R., T.C. Memo. 2011-13, 2011 WL 2436937 (June 14, 2011) (PDF)
26 U.S.C. § 86 (Legal Information Institute)
Photo by Matthew Bennett.