8569 / What other issues relate to the taxation of Social Security and railroad retirement benefits?

Railroad retirement benefits (other than Tier I benefits) are taxed like benefits received under a qualified pension or profit sharing plan. For this purpose, the Tier II portion of the taxes imposed on employees and employee representatives is treated as an employee contribution, while the Tier II portion of the taxes imposed on employers is treated as an employer contribution.¹

As mentioned in Q 8568, the base amount and adjusted base amount of a married taxpayer filing separately who lives with his or her spouse at any time during the tax year is zero. This means it is much more likely that 85 percent of his or her Social Security benefits will be taxable even if the other income is relatively low. As a result, the issue of whether separated taxpayers are living apart is significant.

To address this point, the Tax Court has held that the term “live apart” means living in separate residences for purposes of IRC Section 86(c)(1)(C)(ii). Thus, where the taxpayer lived in the same residence as his spouse for at least 30 days during the tax year in question (even though maintaining separate bedrooms), the Tax Court ruled that he did not “live apart” from his spouse at all times during the year; therefore, the taxpayer’s base amount was zero.²

A taxpayer may elect to treat a lump sum payment of benefits as received in the year in which the benefits are attributable.³

Any workers’ compensation pay that reduced the amount of Social Security received and any amounts withheld to pay Medicare insurance premiums are included in the figure for Social Security benefits.⁴

Another issue that has arisen is whether Social Security disability payments should be lumped in with regular Social Security benefits in determining whether the benefits are taxable. In Green v. Commissioner,⁵ the taxpayer argued that his Social Security disability benefits were excludable from gross income⁶ because they had been paid in lieu of workers’ compensation. The Tax Court determined, however, that Title II of the Social Security Act is not comparable to workers’ compensation, which provides benefits based on a taxpayer’s employment. Instead, the Act allows for disability payments to individuals regardless of employment. Consequently, the taxpayer’s Social Security disability benefits were includable in gross income.

In a case of first impression, the Tax Court held that a taxpayer’s Social Security disability insurance benefits (payable as a result of the taxpayer’s disability due to lung cancer that resulted from exposure to Agent Orange during his Vietnam combat service) were includable in gross income under IRC Section 86 and were not excludable under IRC Section 104(a)(4). The court reasoned that Social Security disability insurance benefits do not take into consideration the nature or cause of the individual’s disability. Furthermore, the Social Security Act does not consider whether the disability arose from service in the Armed Forces or was attributable to combat-related injuries. Eligibility for purposes of Social Security disability benefits is determined on the basis of the individual’s prior work record, not on the cause of disability. Moreover, the amount of Social Security disability payments is computed under a formula that does not consider the nature or extent of the injury. Consequently, because the taxpayer’s Social Security disability insurance benefits were not paid for personal injury or sickness in military service within the meaning of IRC Section 104(a)(4), the benefits were not eligible for exclusion under IRC Section 104(a)(4).⁷