Most retired people, and many not-yet retired peopleImage know that Social Security benefits are subject to federal income taxation. Describing the principle in simple terms is challenging, because the computation of how much of a taxpayer’s social security benefits is included in gross income is complex.

One can say that a portion of Social Security benefits, ranging from zero to 85 percent, is included in gross income, but even that statement fails to convey the reality and it also presumes that identifying social security benefits is easy. I have previously described the complexities in The Joys of IRC Section 86 and More Joys of IRC Section 86. Suffice it to say that law professors who teach the basic federal income tax course do not agree on the depth to which law students should be required to go when studying section 86. It ought to be no surprise that I take my students on the grand tour, not with the purpose of turning them into computational automatons but so that they can understand the concept of the bubble and how marginal tax rates are highest in the lower and middle, and not top, income ranges.

When I teach section 86, one issue on which I do not dwell is the determination of social security benefits. That amount is one of many elements in the computation of the gross income amount. Because of time constraints, the complexity of section 86, and the fact that I can make the points I want to make without getting into the determination of social security benefits, the situations we examine simply reflect some dollar amount of social security benefits.

Yet the determination of Social Security benefits for purposes of engaging in the section 86 computations is more than an abstract conceptual theory in the lives of taxpayers. A recent case, Moore v. Comr., T.C Memo 2012-249, illustrates the significance of the issue. The taxpayer received social security disability benefits of $11,947.20. Of that amount, $5,844 was paid by check to the taxpayers, $1,388.40 was deducted and transmitted for the payment of Medicare Part B premiums, and $4,714.80 was offset because the taxpayer received state workers’ compensation benefits in that amount. The taxpayer’s computation of Social Security gross income began with $5,844, not with $11,947.20. The taxpayer contended that because workers’ compensation benefits are not included in gross income, it would be unfair to require them to include them in gross income by starting the social security gross income inclusion computation with an amount that included the workers’ compensation offset. The taxpayer did not explain why the portion used to pay Medicare Part B premiums had been omitted from the computation, and at trial did not contest the IRS adjustment with respect to that amount.

Section 86(d)(3) provides that “if, by reason of section 224 of the Social Security Act (or by reason of section 3(a)(1) of the Railroad Retirement Act of 1974), 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.” In other words, Social Security benefits for purposes of the section 86 computation include the amount of workers’ compensation benefits to the extent they reduce or offset the total Social Security benefits to which the recipient is entitled.

It does not matter that the taxpayer does not receive the entire amount of the Social Security benefits. This is not an outcome limited to Social Security payments. For example, ignoring tax-deferred and tax-excluded contributions to retirement and other plans, an employee whose salary is $1,000 each week but whose weekly paycheck is less than $1,000 because of federal income tax withholding, state income tax withholding, FICA withholding, medical premium withholding, and similar payroll deductions, nonetheless must report $52,000 of compensation gross income for the year. The principle is that a taxpayer’s gross income computations include amounts that are not received by a taxpayer but that in some way inure to the taxpayer’s benefit.

In a previous case, the taxpayer had raised the same issue. However, that case was settled by a stipulated decision in which no opinion was issued by the court. Although the taxpayer contended that in the earlier case the court suggested that the taxpayer was correct. However, in the case under discussion, the court rejected any reliance on the previous case because it had been settled, no opinion had been issued, and no precedent had been established. At best, it would help the taxpayer escape a section 6662(a) penalty, but the IRS had withdrawn its initial suggestion that the penalty apply.

Law students, who rank among the nation’s brightest, struggle with section 86 even when not asked to do computations. It is no wonder that taxpayers generally stumble when dealing with section 86. Yet in this instance what tripped up the taxpayer wasn’t the calculations, but the selection of the starting number. That amount is clearly stated on the Form SSA-1099 that the taxpayer receives. Even if section 86 had been simplified, this taxpayer almost surely still would have reduced the benefits amount improperly. There’s only so much that simplification can do, but that’s no reason to abandon efforts to attain a simpler federal income tax law.