In Smith v. Commissioner, T.C. Memo. 2026-25, the Tax Court reviewed the 2022 individual income tax return of Michael Smith. During the 2022 tax year, Mr. Smith held jobs with two separate employers, receiving wages totaling $16,535, which he appropriately reported on his Form 1040. However, claiming a disabling injury, Mr. Smith applied for Social Security Disability Insurance (SSDI) benefits in April 2022.

In November 2022, the Social Security Administration (SSA) issued an award letter granting retroactive benefits, and Mr. Smith subsequently received SSDI payments spanning from March 2022 through March 2023. In total, the SSA paid Mr. Smith $26,802 in SSDI benefits during the 2022 tax year, which the agency reported to the IRS on Form SSA-1099. Mr. Smith did not report any of these benefits on his 2022 Form 1040.

In April 2023, the SSA ceased making disability payments after discovering Mr. Smith had been employed since April 2022. The SSA informed him that he "should have never been entitled to receive [a] Social Security disability benefit". Consequently, Mr. Smith was required to reimburse the SSA. He repaid $31,116 in May 2023 and fulfilled the remaining balance via monthly payments across 2023 and 2024. Upon examining his 2022 return, the IRS determined that 85% of the 2022 SSDI benefits ($22,782) should have been included in his gross income pursuant to IRC Sec. 86(a), resulting in a tax deficiency of $5,454.

Taxpayer’s Request for Relief

Mr. Smith petitioned the Tax Court for redetermination, arguing that the $26,802 he received in 2022 was an "accidental overpayment" and was "repaid . . . in full". The taxpayer did not contest the mechanical calculation of the taxable portion of his benefits. Instead, he asserted that the SSDI benefits should be completely excluded from his 2022 gross income due to his subsequent obligation to return the funds, contending that the benefits were "tantamount to loan proceeds that should be excluded from his income".

Court’s Analysis of the Law

The Tax Court evaluated the case under standard summary judgment principles, analyzing the evidentiary foundation of the IRS’s deficiency determination. As the court noted, gross income broadly "includes all income from whatever source derived" under IRC Sec. 61(a), and specifically "includes social security benefits" under IRC Sec. 86(a)(1). The court outlined that up to 85% of Social Security benefits are includible in gross income depending on income thresholds, as dictated by IRC Sec. 86(a)-(c).

Addressing the impact of a repayment, the court analyzed IRC Sec. 86(d)(2)(A), which states that the amount of Social Security benefits received during a taxable year is "reduced by any repayment made by the taxpayer during the taxable year of a social security benefit previously received by the taxpayer".

The court heavily leaned on the "annual accounting principle" codified in IRC Sec. 451(a) and Treas. Reg. Sec. 1.451-1(a), which requires cash basis taxpayers to include items of gross income in the taxable year they are received. To address the taxpayer’s argument regarding his obligation to repay the funds, the court cited the foundational "claim of right" doctrine established in North American Oil Consolidated v. Burnet, 286 U.S. 417 (1932). The court quoted the Supreme Court’s ruling: "If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to [report], even though he might later be required to refund the money".

Application of the Law to the Facts

Applying the law to Mr. Smith’s situation, the Tax Court rejected the taxpayer’s attempt to offset his 2022 income with repayments made in 2023 and 2024. The court stressed that under IRC Sec. 86(d)(2)(A), benefits are reduced only by "any repayment made by the taxpayer during the taxable year". Because no repayment was made in 2022, his 2022 tax liability could not be adjusted.

The court further dismantled the taxpayer’s argument that the overpayment was akin to a loan. Utilizing the claim of right doctrine, the court observed that Mr. Smith "clearly did receive the 2022 benefits under ’a claim of right,’ because he applied for those benefits and SSA issued him a letter affirming his entitlement to the benefits". The restriction on the funds only arose the following year when the SSA reversed its decision upon learning of his ongoing employment.

Conclusions of the Court

Finding no material facts in genuine dispute, the Tax Court granted the Commissioner’s Motion for Summary Judgment. The court concluded that it was "bound by the provisions of the Code" and lacked jurisdiction to consider the tax effects of repayments made outside of the 2022 tax year. The judge firmly ruled, "Any relief to which petitioner may be entitled must be determined for the tax year in which the repayment was made".

Practice Note: Claim of Right Relief Under Section 1341

Although not discussed extensively by the judge in this 2022 deficiency opinion, tax professionals should note how the taxpayer could have used the claim of right statute (IRC Sec. 1341) and its corresponding regulations to obtain relief in the year of repayment.

Under IRC Sec. 1341(a)(1) and Treas. Reg. Sec. 1.1341-1(a)(2), a taxpayer who includes an item in gross income because it "appeared from all the facts available in the year of inclusion that the taxpayer had an unrestricted right to such item," but later establishes that they did not have such a right, may be entitled to targeted relief if the deduction for the repayment exceeds $3,000. Because Mr. Smith repaid $31,116 to the SSA in 2023, he comfortably cleared the $3,000 statutory threshold.

In the year of repayment, Treas. Reg. Sec. 1.1341-1(b)(1) dictates that the taxpayer’s liability is the lesser of:

The tax for the repayment year computed with the deduction taken into account (IRC Sec. 1341(a)(4)), or
The tax for the repayment year computed without the deduction, minus the decrease in tax for the prior taxable year that results solely from excluding the item from the prior year’s gross income (IRC Sec. 1341(a)(5)).

Unfortunately for the taxpayer, while he could have utilized IRC Sec. 1341 and Treas. Reg. Sec. 1.1341-1 to recover the tax paid on the $22,782 inclusion, it seems likely he lost the right to recover the tax paid in 2022 on his benefits (or at least a portion of it) in 2023 due to the closing of the statute of limitations on filing a claim for refund for the repayment year (2023). Because relief must be claimed on the return for the year the actual restoration of funds occurred (2023 in this case), the failure to timely file or amend the return for the repayment year permanently forecloses the taxpayer’s ability to be made whole.

Prepared with assistance from NotebookLM.