Workers’ compensation offset includible in Social Security benefits

An individual’s Social Security benefits that are not disbursed because they are offset by workers’ compensation payments are includible in Social Security benefits for purposes of determining the amount of the individual’s benefits includible in gross income.

Background

Kristen Ecret, who worked as a registered nurse, suffered an on-the-job injury in 2014 and became medically disabled. Due to her injury, she began receiving workers’ compensation benefits in 2014, and she received approximately $42,000 a year in benefits annually until 2019, the year at issue.

In 2017, the Social Security Administration (SSA) determined that Ecret was entitled to SSA benefits related to her injury going back to 2015. Federal law, however, limits the total combined amount of workers’ compensation and Social Security benefits that an individual may receive in a year. While the SSA informed Ecret on a Form SSA-1099, Social Security Benefit Statement, that she had Social Security benefits for 2017, those benefits were offset by the workers’ compensation payments, so no benefits were disbursed to her.

Ecret thought the SSA had gotten things wrong and filed a request for reconsideration of her workers’ compensation offset amount with the SSA. Under 42 U.S.C. Section 424a(a), the amount of combined workers’ compensation and Social Security benefits that an individual may receive in a year is generally limited to 80% of the individual’s “average current earnings” (ACE), which serves as a benchmark to approximate the monthly earnings an individual would have received if not disabled. When payment of Social Security benefits would cause the individual’s combined benefits to exceed 80% of ACE, the SSA must stop disbursing benefits due to what is commonly referred to as the “workers’ compensation offset.”

As a result of the requested reconsideration, the SSA found that it had miscalculated Ecret’s monthly ACE. After correcting its calculations of the ACE, the SSA paid her $3,060 to account for this error.

For 2019, Ecret received a Form SSA-1099 that indicated that she had total Social Security benefits of $55,248, of which $19,866 was attributable to 2019. The balance, or $35,382, reflected retroactive benefits attributable to 2016–2018. The form indicated that $6,120 was paid to her “by check or direct deposit” and another $1,080 was paid as voluntary federal income tax withholding. The balance of the $55,248 in benefits, or $48,048, was not paid to Ecret, on account of the workers’ compensation offset.

On their joint federal income tax return for 2019, Ecret and her husband reported $5,202 as taxable Social Security benefits. They did so based on their belief that the only amount includible in Ecret’s income from the Social Security benefits was the cash paid to her by the SSA ($6,120) and that under Sec. 86(a)(2)(B), a taxpayer’s taxable Social Security benefits are a maximum of 85% of their Social Security benefits. 

On audit of the Ecrets’ joint return, the IRS determined that, under Sec. 86(d)(3), the Social Security benefits should be increased by $49,128, the sum of the $1,080 of voluntary income tax withholding and the $48,048 of Social Security benefits not paid due to the workers’ compensation offset. The IRS issued the Ecrets a 2019 deficiency notice including an increase in gross income of $41,759 ($49,128 × 0.85). The Ecrets filed a Tax Court petition challenging the IRS’s determination.

After trial in the case, the IRS conceded that the Ecrets were not liable for income tax in 2019 on the portion of Ecret’s Social Security benefits that were a retroactive payment attributable to 2016–2018. However, while it reduced the amount of Social Security benefits it claimed Ecret received in 2019, it continued to maintain that she should be considered to have received Social Security benefits of $19,866, the sum of the $6,120 cash payment from the SSA, the $1,080 of voluntary income tax withholding, and the $12,666 of 2019 Social Security benefits not paid on account of her workers’ compensation offset. The IRS contended that under Sec. 86(a)(2)(B), 85% of this amount, or $16,886, should be included in the Ecrets’ gross income for 2019. The Ecrets countered that only the amounts paid to them in cash by the SSA could be subject to tax.

The Tax Court’s decision

The Tax Court held that Ecret’s 2019 Social Security benefits were $19,866, including the $12,866 she was treated as receiving under the Sec. 86(d)(3) workers’ compensation offset provision, and, after applying an 85% inclusion ratio, $16,866 was taxable Social Security benefits includible in the Ecrets’ gross income.

Sec. 86(a)(1) provides that, to the extent of the specified inclusion ratio, “gross income … includes social security benefits.” In general, “social security benefit” is defined in Sec. 86(d)(1)(A) to include “any amount received by the taxpayer by reason of entitlement to … a monthly benefit under title II of the Social Security Act.” This general definition is modified by Sec. 86(d) (3), which provides that for purposes of Sec. 86, “if, by reason of section 224 of the Social Security Act [i.e., 42 U.S.C. Section 424a] … any social security benefit is reduced by reason of the receipt of a benefit under a workmen’s compensation act, the term ‘social security benefit’ includes that portion of such benefit received under the workmen’s compensation act which equals such reduction.”

Accordingly, the amount of an individual’s taxable Social Security benefits includes workers’ compensation payments to the extent those payments offset Social Security benefits to which the individual is entitled. Sec. 86(d)(3) was enacted to equalize the treatment of taxpayers like Ecret with that of taxpayers living in states where the receipt of Social Security benefits reduces workers’ compensation benefits.

Considering the facts of Ecret’s case, the Tax Court found that, after redetermining the amount of benefits not paid to Ecret on account of her workers’ compensation offset, the IRS had properly calculated her taxable Social Security benefits for 2019. The court determined that her Social Security benefits were $19,866, which was the sum of the $6,120 disbursed to her as a cash payment, her $1,080 federal income tax withholding payment, and the $12,666 not disbursed to her due to the workers’ compensation offset (includible in Social Security benefits under Sec. 86(d)(3)). Multiplying that by an 85% inclusion ratio under Sec. 86(a)(2)(B) (which the Ecrets did not disagree with), the court found that $16,886 (i.e., $19,866 × 0.85) of Ecret’s Social Security benefits were taxable.

Reflections

The IRS also audited the Ecrets’ 2018 return, and on Aug. 9, 2021, issued the couple a separate notice of deficiency for 2018 that included a similar upward adjustment to gross income for additional taxable Social Security benefits. The Ecrets disputed the deficiencies for 2018 in the same Tax Court petition in which they disputed their deficiencies for 2019, which they filed on Feb. 22, 2022. However, while the petition was timely for the 2019 notice, it was filed 108 days late for the 2018 notice. Consequently, the court dismissed the Ecrets’ case for lack of jurisdiction with respect to their tax liability for 2018.

Ecret, T.C. Memo. 2024-23 

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.