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Tracing Social Security Payments

Posted on Sep. 26, 2022

Social security funds provide a safety net for recipients and generally receive protected status from creditors. The case of In re Weber, 130 AFTR2d 2022-5161 (Bankr. M.D. Fla. 2022) examines what happens to social security payments when the taxpayer uses them to pay federal income taxes and then receives a refund partially based on the social security payments. The bankruptcy court allowed Mr. Weber to shield the portion of his tax refund which represented the return of his social security payments citing to 42 USC 407. The decision speaks to the power of the exemption of social security funds from private creditors.

Mr. Weber filed a chapter 7 bankruptcy petition in February of 2022. At issue is his 2021 income tax refund which the trustee seeks to claim as an asset for the benefit of the general unsecured creditors of the bankruptcy estate. Mr. Weber argues that a substantial portion of the refund resulted from his decision to have money withheld from his monthly social security payments to pay federal taxes. He overestimated what his federal tax obligation for 2021 would be for reasons not explained in the opinion. Mr. Weber’s position is that just because he had a portion of his social security payment used to pay an anticipated federal tax liability did not change the character of the funds to such a degree that they lost the protection afforded to social security payments.

You might ask why Mr. Weber had any taxes withheld from his social security payments. The opinion indicates that he had a part time job as an employee. The income from that job in 2021 was only $378.00 per month. Based on that level of income, he would not have triggered any of his social security payments to become taxable, and he could have used wage withholding from the job to cover any taxes from his employment. The facts suggest that his decision to withhold from his social security in 2022 was unnecessary. We are not given information about prior years when his wages could have been higher and could have come from work as an independent contractor rather than an employee. Higher income could have triggered tax on a portion of his social security payments making the withholding of a portion of the payment logical. If he worked as an independent contractor, he might have found it simpler to have some of this social security payments withheld than to make quarterly estimated tax payments. We just don’t have enough information to evaluate his thought process in having the withholding. We do know that he overwithheld from his social security payments and that a significant portion of his 2021 refund resulted specifically from that withholding.

The trustee argued that once Mr. Weber’s social security payment went to the IRS as withholding for payment of taxes it lost its character as a protected social security payment and transformed into simply a tax payment the refund of which the trustee could reach for the benefit of the estate. The trustee’s position is supported by the decision of the bankruptcy court in In re Crutch, 565 B.R. 36 [119 AFTR 2d 2017-1428] (Bankr. E.D.N.Y. 2017).

The bankruptcy court in Mr. Weber’s case stated:

Under 42 U.S.C. § 407, social security benefits are not subject to execution, levy, attachment, garnishment, or other legal process, and no other provision of law may limit or modify the exemption from execution except by express reference to the statute.

It acknowledged the Crutch decision but cited to another bankruptcy court decision, In re Spolarich, 2009 WL 10267351 (Bankr. N.D. Ind. Sept. 30, 2009), which it found more persuasive. The court in Spolarich found the protection for Social Security payments exceptionally expansive and only subject to modification by express statute. It determined that when a social security recipient uses a portion of that payment for tax withholding, the individual’s consent to the use of those funds extends only to the payment of tax liabilities and not to the payment of other claims stating:

[B]y the clear language of 26 U.S.C. §§ 3402(p)(1), the election to withhold [funds from social security payments] benefits only the Internal Revenue Service, and does not constitute a general waiver of the protections of § 407(a) with respect to Social Security benefits vis-à-vis other entities.

The bankruptcy court in Mr. Weber’s case agreed with the analysis in Spolarich and allowed him to exempt that portion of his 2021 tax refund traceable to the withholding of his social security payments.

We have discussed tracing of payments exempt from IRS levy in several posts.  This post written by Les discusses the issue and links to earlier post which also discussed the character of a protected payment once moved to an unprotected source. The issue of tracing arises in many contexts. While the language of the social security statute may be particularly strong, the analysis here may be useful in other settings. The policy issue of when a protected payment loses its special status is one worth considering. If the Weber court got it right should the language of 42 USC 407 serve as a model for other statutes in which taxpayers receive payments protected from levies? Can Weber assist taxpayers trying to fend off a levy to their bank account find assistance from the approach here?

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