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Disability & SS

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TP received disability from ins co for 09,10,11. TP receives SS lump sum in 2011 for 09,10 plus regular benefits for 2011. Ins co promptly pulls all funds it paid out. TP did not report SS on 2011 return. IRS sent CP 2000 for unreported SS on 2011 tax return. The amount we are looking at is 39K in SS. AGI on return 95k. It looks like IRS only Taxed 85% however INS took 100%. TP did report and pay tax on disability for years in question. Question is how would you handle this? Many thanks for replying.

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Guest Taxed

Under the federal "Claim of Right" Doctrine, taxpayers receiving income under a claim of right and without restrictions on its use or disposition are taxed on that income in the year of receipt even though the right to retain the income is not yet fixed or they may later be required to return it.

If taxpayers later repay amounts received under a Claim of Right because they did not in fact have a right to it, they may be entitled to a deduction federally in the year of repayment for the amount repaid that was included in the earlier year's gross income. The deduction is allowed only if taxpayers are otherwise entitled to a deduction under some other provision of the Code, e.g. IRC §§ 162, 212, etc.

If the amount of the deduction exceeds $3,000, taxpayers may compute their tax liabilities for the year of repayments pursuant to IRC § 1341 to relieve them from possible hardship due to the federal progressive rate structure.

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>>It looks like IRS only Taxed 85% however INS took 100%.<<

In spite of what I said before about 1040X during an audit ["IRS CP2000 Problem"], you might need one this time because you have new issues.of the deduction/credit for the repayment and lump sum treatment of the SS. (See Pubs 525 and 915 for details.)

But CALL first! Be sure to have POA ready to fax (or client present). Also, have ALL the source documents, worksheets, and draft forms completed in hand before you call. That means redoing all federal returns back to 2009, a state amendment for 2011, and a written request for penalty abatement describing the reasonable cause. You should be able to resolve the matter with that single phone call and one followup fax or mailing (plus mailing the state amended return),

As always, I highly recommend an engagement letter so there is no misunderstanding. You can not guarantee any specific results from the audit, and the client is responsible for all taxes, interest and penalty. However, I don't think you should charge a fee if you knew or should have known that the client received Social Security benefits.

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