The Tax Court held that a taxpayer was not entitled to a loss deduction for the amount his Federal Employees Retirement System (FERS) disability annuity was reduced because he was also receiving Social Security Disability Insurance (SSDI) benefits.
Mark Staples was a patent examiner for the U.S. Patent and Trademark Office. He retired due to disability in November 2012 and applied for FERS disability benefits. He was granted a FERS disability annuity from November 2012 on, but he was instructed by the Office of Personnel Management (OPM) to apply for SSDI benefits, which he did.
Staples was granted a monthly SSDI benefit effective March 1, 2012. In response to his receipt of SSDI benefits, OPM initially reduced his monthly FERS annuity by 100% of his monthly SSDI benefits for the months in which he received both. Beginning Dec. 1, 2013, OPM recomputed his FERS annuity, resulting in a monthly reduction equal to 60% of his monthly SSDI benefits. When Staples turned 62, OPM again recomputed (effective Aug. 14, 2015) his FERS annuity using an amount that essentially represented the annuity he would have received if he had continued working until the day before his 62nd birthday and had retired under the FERS nondisability provisions, again reducing his FERS annuity.
In March 2016, Staples filed his federal tax return for 2015. On his return, he included both his FERS annuity and his SSDI benefits as income. However, he left out a taxable distribution from a retirement account (and withholding on that distribution) and a small amount of interest. The IRS sent him a Notice CP2000 stating that he owed $742, which was additional tax and interest of $1,671, less the additional withholding of $929. Staples in his response conceded that he had received the extra income but contested the imposition of the additional tax. He nonetheless included with his response a check for $742 to pay the amount the IRS claimed he owed, which the IRS treated as a deposit.
Staples's rationale for not owing the additional tax was that he was also entitled to a loss deduction in the amount of the reduction of his FERS disability annuity due to his receipt of SSDI benefits, which would offset the additional income on the Notice CP2000. This loss was not reflected on Staples's original return, so in September 2017 he filed an amended return that included the loss deduction. The IRS refused to process or accept the amended return. In January 2018, the IRS sent Staples a notice of deficiency for additional tax of $1,635. Staples challenged the IRS's determination in Tax Court.
The Tax Court's decision
The Tax Court held that Staples could not claim a loss deduction for the reduction in his FERS disability annuity. While Staples claimed he had a loss akin to a gambling, casualty, disaster, theft, or business loss as a result of the reduction, the court found that Staples did not have one of these types of deductible losses but instead had a nondeductible loss of unrealized income.
As the court explained, the reduction of an individual's FERS disability annuity when the individual also receives SSDI benefits is required by statute, and the legislative history around the rule clearly indicates that this rule was created intentionally to prevent a potential overlap between a FERS disability annuity and SSDI benefits that could result in certain individuals' being overly compensated. Furthermore, the FERS disability annuity reduction due to the receipt of SSDI benefits has been challenged and upheld in many previous cases.
Regardless, the Tax Court found that it lacked jurisdiction to decide employee benefit entitlement issues. Therefore, the sole issue before it was whether the reduction to Staples's FERS disability annuity was a loss for which he was entitled to a deduction in the amount of the reduction.
The court concluded he was not entitled to the deduction because he did not have a deductible loss from the reduction of the FERS disability annuity. Rather, the reduction in the annuity caused him not to receive expected additional income or, in other words, a loss of unrealized income. As many courts, including the Tax Court, have held, no section of the Code allows for the loss of unrealized income by a cash-basis taxpayer. Staples was a cash-basis taxpayer, so the Tax Court held he was not entitled to deduct the reduction of the FERS disability annuity because of his receipt of SSDI benefits.
As the Tax Court points out in its opinion, Staples is not the first person to take issue with the reduction of a FERS disability annuity due to the simultaneous receipt of SSDI benefits. Although the law is clear that these FERS annuity reductions are allowable, the perceived grievous unfairness of this rule leads many people on quixotic quests to the courts for relief. He is also not the first person to argue that failure to realize anticipated income somehow amounts to a deductible loss (see, e.g., Marks, 390 F.2d 598 (9th Cir. 1968)). However, he may be the first person to combine these two mistaken ideas into one to argue that the reduction to a FERS disability annuity amounts to a deductible loss.
Staples, T.C. Memo. 2020-34