Repayment of disability

[JenMO]

Client became disabled in 2011, started drawing her company's disability insurance. In 2012 kept drawing the disability insurance, but in June Soc Sec judged her disabled too, she received soc sec benefits for 2011 and for 2012. She had to pay back her insurance company for overpayment for 2011 and part of 2012. Now I have to do a repayment on the 2012 tax return. The disablility was given as w-2 wages, and the instructions say the repayment is done on the Sch A, misc deductions. Doesn't seem quite fair that her repayment is first taken up by the standard deduction. Is this correct?
Another question - her disability is reported on a W-2 as third party sick pay (taxable), she sends her child to daycare, does that qualify her for the child care credit?

[Koss]

Repayment

Schedule A is one option. However, if the repayment is more than $3,000, then there is an option to take a tax credit instead of a deduction.

See this section of Pub. 17:

http://www.irs.gov/publications/p17/ch12.html#en_US_2012_publink1000172015

BMK

[Koss]

Child Care Credit

You wrote:

her disability is reported on a W-2 as third party sick pay (taxable), she sends her child to daycare, does that qualify her for the child care credit?

The answer is yes, if the reason her children are in day care is because she is unable to care for them as a result of her disability.

If they kids are in day care so she can play bridge, or go horseback riding, then no, that doesn't qualify for the credit.

For purposes of the Child Care Credit, earned income includes disability pay that is reported as wages. See page 216 of Publication 17 (2012).

BMK

[Koss]

Wait a minute...

You said the repayment was for benefits she received in 2011 and 2012.

The amount repaid with respect to 2011 is a repayment, and I as I noted above, if it is more than $3,000, she may be able to take a tax credit.

But the amount repaid in 2012 is not treated as a repayment. If she received benefits in 2012, and also repaid part or all of those benefits in 2012, then I think it should be netted out on Form W-2...

BMK

[JenMO]

I talked with the insurance people, and he said the repayment for 2012 is not reflected in the w-2. But I guess I'll have to find out what was for 2011 and how much was for 2012? The amounts are over $3000.

[Koss]

Repayment

Yes, you certainly need to know how much was for 2011 and how much was for 2012.

But the process used to calculate the tax credit is only applicable when the taxpayer has made a repayment of income that was received in a prior year. The tax credit calculation only makes sense with respect to the amount repaid that was originally reported as income on the 2011 return.

Maybe I am mistaken in my assertion that the repayment for 2012 should be "netted out" on Form W-2. I don't know for sure whether the employer--in this case the insurance company--is required to "back it out" of the amount reported on Form W-2.

One thing that probably makes this case a little bit less complicated... I'll bet the third party sick pay, even though it is reported on Form W-2, is not subject to social security or medicare tax. Right?

Regardless of whether the amount repaid should have been backed out of Form W-2, I stand by my position that for wages that were earned and repaid in 2012, the tax credit is not applicable. It is also inappropriate to take a deduction on Schedule A.

Wages that were earned and repaid in the same year are excluded from gross income.

See SCA 1998-026. It says:

- - - -
The federal income tax consequences of the repayment of wages previously received under a claim of right depends upon the year of repayment. If repayment is made in the same calendar year that the wages were received under a claim of right, the amount is excluded from gross income. The repayment results in a reduction in gross income and wages rather than a deduction. See Couch v. Commissioner, 1 B.T.A. 103 (1924), acq., IV-1 C.B. 1 (1925).
- - - -

Here's a link to the source:

http://www.irs.gov/pub/irs-wd/1998-026.pdf

For wages earned in 2011 and repaid in 2012, I also stand by my original assertion. A deduction on Schedule A is one option. The other option, if the amount in question exceeds $3,000, is to calculate a credit under IRC 1341.

FYI: Wages earned, and then repaid, were in fact "received under a claim of right." This terminology sounds very mysterious and very complicated, but it isn't. It simply means that at the time the person originally received the income, they reasonably believed that they had an unrestricted right to the income. In other words, at the time they received it, they did not know they would have to pay it back.

BMK


BMK

[Koss]

Exclusion

For the amount earned in 2012 and repaid in 2012, the solution may be to back it out as an adjustment on line 36.

Or a negative entry on line 21.

BMK

[JenMO]

Ok, thanks, back to the insurance co. I'll deduct on line 21 the amount overpaid for 2012, and figure the credit for 2011. Now if they will tell me the numbers. Someone has to know