Social Security disability benefits taxable even though offset by nontaxable worker's compensation

An individual received both Social Security disability benefits and state worker's compensation benefits. For 2009, the Social Security Administration (SSA) reported that taxpayer's total disability benefits were $11,947, which included a $4,715 offset for worker's compensation. Because worker's compensation benefits are generally nontaxable under Code Sec. 104(a)(1), the taxpayer reported only $5,844 in Social Security benefits on her joint 2009 tax return, which was the net amount she received from the Social Security Administration. However, the IRS determined that the full $11,947 should have been reported, of which 85 percent was taxable.

The taxpayer cited Code Sec. 104(a)(1) and claimed that it was unfair to include the worker's compensation amount in her taxable Social Security benefits. The Tax Court found that, not only does Section 86 of the Social Security Act include Social Security benefits in gross income, but that under Section 86(d)(3), if any Social Security benefit is reduced because of a worker's compensation benefit, the "Social Security benefit" includes the amount received under the worker's compensation act. Thus, even though the SSA did not pay the worker's compensation benefits to the taxpayer, they were includable in gross income.

The IRS admitted, however, that although the statute is clear on this point, the result was not obvious. Therefore, the IRS conceded that the taxpayer was not liable for the Code Sec. 6662(a) penalty.

If you have any questions regarding Social Security or worker's compensation benefits, please contact Doeren Mayhew.