15.3 SSI and Social Security

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.