Cancellation or waiver of an overpayment of government assistance may constitute debt cancellation income.1  However, waiver of an overpayment due to economic hardship should be excluded from income under the general welfare exclusion doctrine.2

• 1See, e.g., Waterhouse v. Comm’r, T.C. Memo 1994-467 (waiver of VA overpayment creates debt cancellation income); see also IRS Chief Counsel Opinion CC: Pa: 01: RJGoldstein, PRESP-109087-12 (Mar. 9, 2012).
• 2See, e.g., Rev. Rul. 78-46, 1978-1 C.B. 22.

Unemployment compensation is subject to income tax, but not to FICA or self-employment tax.1  If there is no withholding on unemployment compensation, taxpayers may face underpayments and penalties when they file their next tax return. To avoid these problems, a taxpayer can pay quarterly estimated tax payments or file a Form W-4V to have 10% of their unemployment compensation withheld for taxes.

• 1I.R.C. § 85.

SSI benefits are not subject to income tax (except possibly in cases of fraud). However, lump sum Social Security benefits and ongoing Social Security benefits may be subject to income tax. After 1983, even Social Security disability benefits are subject to tax.1  Generally up to 50% of Social Security benefits are taxable for low-income taxpayers. Additional income from employment, retirement, and gambling are common reasons that Social Security benefits become taxable. Cancellation of a large debt could make Social Security taxable in the year of cancellation if the debt cancellation income can’t be excluded from income.

Social Security benefits are included in gross income for the tax year in which the benefits are received.2  The taxpayer may make an election to attribute a portion of the lump sum benefits to prior tax years.3  This election should lower the tax impact of a lump sum Social Security benefit. The taxpayer’s attorney fees for the disability appeal may be deducted from income to the same extent that Social Security is taxed.4  This limited deduction is a Schedule A deduction and subject to the 2% of adjusted gross income limit on certain itemized deductions. If the taxpayer uses all or part of a Social Security lump sum payment to reimburse the taxpayer’s long-term disability carrier, special tax relief may be available under I.R.C. § 1341. If the repayment to the LTD carrier is under $3,000, the taxpayer gets a deduction on the current year’s return. If the repayment is over $3,000, the taxpayer chooses either the deduction or a tax credit for the excess tax paid in the prior year.

• 1See Payne v. Comm’r, T.C. Summ. Op. 2011-59; Reimels v. Comm’r, 123 T.C. 245 (2004); Maki v. Comm’r, T.C. Memo 1996-209.
• 2I.R.C. § 86(a)(1); Green v. Comm’r, T.C. Memo 2006-39, aff’d, 262 F. App’x 790 (9th Cir. 2007).
• 3I.R.C. § 86(e). For a detailed explanation of the election and worksheets, see IRS Publication 915.
• 4Rev. Rul. 87-102.

Generally, public disaster assistance will be excluded from income under I.R.C. § 139 or the general welfare exclusion doctrine.

Under the general welfare exclusion doctrine, most welfare payments will be excluded from income.1  The criteria for exclusion under this doctrine are payment from a government general welfare fund, promotion of general welfare (i.e., the payment is based on need), and the payment not made for services.2

Fraudulently obtained public assistance is taxable income. Cancellation of an overpayment of public assistance may create debt cancellation income unless excluded by the Internal Revenue Code or the general welfare exclusion doctrine.3

• 1For a list of revenue rulings and court cases applying or denying exclusion under the general welfare exclusion doctrine, see I.R.M. 4.88.1, Ex. 4.88.11-3.
• 2See Robert W. Wood, Updating General Welfare Exclusion Authorities, 123 Tax Notes (TA) 1443 (June 22, 2009); Bannon v. Comm’r, 99 T.C. 59 (1992).
• 3See, e.g., Waterhouse v. Comm’r, T.C. Memo 1994-467 (waiver of VA overpayment creates debt cancellation income).

The Earned Income Credit (EIC) does not count as income for Medicaid, food stamps, SSI, or federally subsidized housing.1  States can set their own rules for how the EIC is treated for TANF eligibility. So far, no state has counted EIC refunds as income for TANF eligibility.

By federal law, states are prohibited from counting the EIC refund as an asset for Medicaid, SSI, food stamps, or federally subsidized housing unless it is unspent by the end of the month after the month of receipt. A state may have rules that are more favorable than the minimum federal rule against counting EICs as assets.

• 1See I.R.C. § 32(l).

Immediately before a levy of Social Security benefits, the taxpayer should receive a CP 91 or CP 298, Final Notice Before Levy on Social Security Benefits. The CP 91/298 notices should have been preceded by a Notice of Intent to Levy and Notice of the Right to a Collection Due Process (CDP) Appeal. The taxpayer has 30 days to respond to the Final Notice and may still appeal through the Collection Appeal Program even though the right to a CDP appeal has been lost.1  If it has been less than a year since the Notice of the Right to a CDP Appeal, a taxpayer who missed the 30-day period for requesting a CDP appeal may also have a right to an “equivalent hearing” before an IRS appeals officer.2

Under the Federal Payment Levy Program, the IRS may continuously levy 15% of monthly Title II Social Security benefits and most welfare benefits other than SSI. The IRS no longer levies against Social Security benefits that are less than $750 per month. Levies against Social Security benefits greater than $750 can often be prevented or removed by applying for Currently Not Collectible status. It is important to respond promptly to a proposed Notice of Levy on Social Security benefits. Once the levy is imposed, it can take time to get the levy removed and wrongfully levied amounts refunded. If the IRS levies in excess of what is allowed by law, you have 9 months in which to request a return of the excess amount.3

Beginning February 2011, the IRS may exclude Social Security recipients with income less than 250% of the federal poverty guideline from the Federal Payment Levy Program if Social Security is their sole source of income.4  However, because the IRS has refused to apply the 250% poverty filter to non-filers, low-income taxpayers still receive Social Security levies. A low-income Social Security recipient who gets a levy notice may be a non-filer and need assistance with filing any delinquent returns.

• 1I.R.M. 5.10.1.7.3, .11.7.2.4; I.R.M. 8.24.1.2.
• 2I.R.C. § 6330(b). Unlike the CDP appeal, a decision in an “equivalent hearing” or Collection Appeal Program appeal may not be reviewed by a court.
• 3I.R.C. § 6343(b), (d); I.R.M. 5.11.2.3.1 (8-24-10).
• 4I.R.M. 5.11.7.2.2.3.