Tax error question... Need tax expert/attorney advice

In My Humble Opinion
1

We have a friend who is on long-term disability and has been for a very long time.

She said that she was notified by the company that pays her disability (as I understand it, her employer has an insurance company that pays disability claims that are filed by employees… I guess this is how most of these things are handled.)

It turns out, the insurance company that was paying her monthly was taxing her incorrectly. They paid the IRS at a higher rate than her company’s policy (or the IRS specifies, I don’t know), and as a result, they overpaid her taxes… She received 3 years of corrected W2 forms (W2-C’s, I believe) and was told that the IRS will not permit them to go back further than that.

This woman has unknowingly overpaid her taxes over the years and it adds up to 10’s of thousands of dollars.

She has contacted both her employer and the insurance company that made the error, and has been given some troubling answers.

The error was tracked down, and it was the insurance company that made the mistake. They told this woman that the IRS will only permit going back 3 years, and they are sorry. It was an “administrative error”, and there is nothing they can do.

I think this is BS, and told her that IMO, the insurance company made a mistake and doesn’t want to pay the money owed to her because they will have to pay it. The 3-year rule is, I am sure, the IRS law, but that doesn’t mean the insurance company is off the hook.

There is another thing here that may be at work, but I don’t know enough about her employer, the insurance company, or the bigger picture. But I would think that this “administrative error” could be something that has been propagated throughout the years with a number of employees that are on disability, and now that it has been discovered, the insurance company could be looking at a hefty bill. I think there could be a potential class-action lawsuit with a number of people who are owned thousands of dollars, but since the people on disability probably don’t know each other, they won’t be able to compare notes. I would guess an attorney who knows his way around this area would have to seek out the employees, but due to the confidential nature of employee records, I don’t know how easy or hard this would be.

I spoke to my tax professional, who said they cannot see how this woman should not get all of the money owed to her, but since they were not an attorney, she suggested the woman contact one. Obviously, this is good advice.

This is not a wealthy woman. Unless an attorney would be able to take this on and either do it on a contingency basis or sue the insurance company for a significant sum to make it worth their while, she may have to come up with the money up front. This is not something that would be easy for her to do.

She doesn’t want to take this to court… She has severe mobility issues, so her preference is to not do that. But she will. She is a fighter. And she could definitely use the money. To her this is a matter of principle. It wasn’t her fault, she didn’t make the error, and she is being told she has to pay for it. Personally, I think she’s right, but unfortunately for her, all we can do is offer her moral support, transportation when we can, and help with some research.

I have this fantasy that the insurance company will do the right thing, and pay her the money back. Or, the IRS will, after hearing the issue, agree that this was an error that should not impact an innocent person, and they will give the insurance company permission to file updated W2’s for every year this occurred. I know, however, that life doesn’t work this way. Her insurance company has staff attorneys, and my guess is they have already worked out a strategy to deal with this, especially if it is a widespread issue.

Perhaps once the insurance company realizes this woman is not going away, they will do the right thing and pay her the money that is rightfully hers. Or maybe, as I said, the IRS has some flexibility with their 3 year limit when they are presented with the facts of a situation such as this.

If it goes to court, I would personally think the woman would not only get her money, but the interest that would have accrued during the decade plus this has been going on, plus court and attorney fees, and any additional damages the lawyer and court deemed appropriate.

However, IANAL, which is why I am posting this out here. My personal feelings about this situation won’t make this right for her.

And yes… Disclaimers are implied and stated. I understand that this is a message board, and no one will be responsible for any advice they give, legal or otherwise… So no worries there.

Thanks for reading.

2

Legal advice is best suited to IMHO.

Colibri
General Questions Moderator

3

IANAL, but if the facts are as presented, this sounds like something a contingency-fee lawyer would jump at. The IRS won’t give back a dime, but the insurance company messed up and should pay.

The only thing that worrys me is this -

It isn’t a matter of principle. It’s money. She needs to recognize that she probably won’t get any money unless she hires an attorney, and if she hires an attorney, he is going to take a cut - a third is the figure I have heard.

And the goal should be to settle, not sue. A suit will take more time, and her attorney will still get a third.

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4

So the insurance company was paying more in taxes than they were reporting on her W2 forms?

5

This seems off. If they just withheld too many taxes, she should have gotten refunds.

Was part of her benefit supposed to be tax-free? LTD insurance benefits are tax-free if the employee paid the premium with after-tax income (or a percentage of the benefit is tax-free if the employer and employee split the cost). I wonder if part of her benefit was supposed to be tax-free, but the insurer was reporting the whole amount as taxable. This would be harder to catch, particularly if you aren’t clear about the particulars of your policy and the tax law.

If the latter is the case, she needs to get a lawyer and find out what her avenues of recourse are.

6

Of course there’s something they can do–they can pay her the money they screwed up. She should talk to the IRS about getting the 3 years refunded, but she’ll likely have to sue the insurance company to get the rest of the money.

The insurance company can’t just throw their hands up and say “Oh well. We screwed up and lost thousands of dollars. Oopsie!” She’ll likely have get an attorney to fight this for her. The insurance company isn’t going to just give up the money because she asked.

7

No.

As I understand it, her earned income on disability is supposed to be reported as a lower income, and the tax withheld is on that lower total. I can ask my wife if she remembers the exact percentage, but for some reason, 70% jumps out in my head…

So, (again, this is how I’m understanding the situation… You are getting this from a non-tax person who is just trying to help). I know this will get wordy, so apologies in advance…
I will use easy numbers to outline what happened vs. what should have happened.

Let’s say her annual salary on disability is $10,000. As a regular employee, she would be taxed on 100% of those earnings, or $10,000. The W-2 shows the earnings and the taxes already withheld. There are two earnings boxes on a W-2. Earnings and adjusted earnings. The adjusted earnings is what the tax should be based on. In her case, both numbers (earnings and adjusted earnings) on her W-2 were the same… $10,000.

But what should have happened is when she went on disability, the insurance company was supposed to tax her adjusted income. So in my example,

Her earned income would be $10,000, BUT
her adjusted income would be $7,000

And she would be taxed as if she only made $7,000 instead of $10,000.

I hope that makes sense.

She did not know (nor did anyone tell her) that she should have seen an adjusted income entry on her W-2 that was less than her regular income.

Again, apologies if I am not explaining this well. I think I got the general idea, though.

8

Missed this before I posted.

Yes, I think this is what happened. Part of her income is now considered non-taxable.

As I mentioned, the tax was taken out of her income that was on the W-2. Since both the regular income and adjusted income was the same on her W-2, no one caught it for years. I am not saying this was a mistake the insurance company made on purpose… But now that it has been discovered, they should have to compensate her.

I will try to answer the replies in this thread later tonight when I have a chance to sit down.

In the meantime, thanks all for the replies thus far

9

I am curious about costs. Over here, a lawyer would take up the case on a no-win-no-fee basis. If they lost the case it would be their (or their insurer’s) loss. If they won, the loser - the insurance company that pays disability claims - would not only pay all the cash owed, plus accumulated interest and costs, but all of the costs of the lawyer (naturally inflated to the max)

For this reason, nearly all claims are settled out of court - thus avoiding most of the costs.

10

Just to belabor the obvious:

The business is going to look at this strictly from a dollars perspective, and not a “do the right thing” perspective. Step one for them is to do the bare minimum that they are required to do. Hence, the three years of corrected W-2s. Step 2 is to minimize any further damage. They are doing this by saying “That is all the IRS is allowing us to do.” It sounds plausible and reasonable to most people, and a certain percentage of their customers will drop the matter.

Your friend has to force the issue by hiring a lawyer to make them realize there is going to be a step 3 (negotiations for additional compensation) and maybe even a step 4 (lawsuit). Those steps represent additional costs to the company, and when they see further costs are looming then at some point they will be willing to settle (or go to court), making their decision on the basis of dollars and cents.

She also should accept that she probably will not ever be made whole, but she can at least get some percentage of what she is due.

11

The US system is different than the British system. The default assumption is that each party pays its own legal costs, win or lose. Many plaintiff’s lawyers in civil proceedings are willing to take cases on a contingency basis, meaning that they deduct a percentage (typically 33% to 40%) from their client’s winnings to reimburse themselves for their efforts. Obviously, lawyers are not going to take small cases on contingency and defense attorneys do not work on contingency.

Many contracts do contain clauses that one party will pay the other party’s legal fees, and there are statutes that do say that in certain types of cases the losing party must pay the winner’s costs. I believe that Florida and Nevada have rules that a party that declines a settlement offer but does not get a better result at trial has to pay the other party’s legal fees.

This results in things like Strategic Lawsuits Against Public Participation (SLAPPs). Many times if a financially weak person is making trouble for a large corporation, the corporation will bring a lawsuit designed to bankrupt the trouble maker with legal fees even though they may have little realistic hope of winning it. California has passed a notorious anti-SLAPP law that itself has had many unintended side effects.

12

Just a couple of technical points:

If she filed a federal extension in 2012 for her 2011 taxes, she still has until three years after the she filed her 2011 return or October 15. 2015 (whichever comes first) to request a federal refund for 2011. If she didn’t file an extension, she is out of luck. (Side note: This is one of the many reasons that people who say “there is no reason to file an extension if I’m expecting a refund” are wrong.)

Some states also have a statute of limitations longer than the federal statute. California, for example, is four years. You may still be able to get a state refund even if the federal refund is barred.

And consult with a lawyer promptly. There may be a non-tax state statute of limitations that could prevent her from getting any restitution from the insurance company. And, since the insurance company seems to have only been an administrator for the employer’s compensation program, you may also have a cause of action against the employer (as well as the insurance company). A qualified attorney should be able to pick up on this point.

13

Both principle and principal! :smiley:

14

Contingent attorney’s fees are generally limited by ethical rules to “a reasonable fee”, which may or not be a fixed percentage. Where fixed percentages exist they are typically 33% to 40% of the client’s recovery.

Very few employers are self-insured for short- or long-term disability benefit plans, and even if they were the benefits would not be reported on a W-2. I think the OP is a bit confused on that point.

15

Lots of LTD insurers report paid benefits on a W-2.

Sounds like the friend probably paid a percentage of the LTD policy premium herself, and the employer paid for a percentage of the premium. The proportion Friend paid with after-tax dollars should be the proportion of her benefit that is tax-free. The proportion the employer paid for should be taxed.

The taxable portion of her benefit should be reported in Box 1 on her W2. The portion that is untaxed is reported in Box 12a. Just so she knows what to look for in the future, to know it is done right.

She needs a lawyer, but I would not be surprised if the statute of limitations on a claim against the disability insurer has expired.

16

I agree that she needs a lawyer. The first issue to address here has nothing to do with right or wrong and everything to do with statute of limitations. The tax statute has been addressed. I don’t know anything about the laws applying to the insurer’s error, and your friend should definitely explore every option that might be available to her.

However, I do want to address one point: each individual has the responsibility to ensure that their tax information is correct. You cannot just blindly report what’s on your W-2 and assume that everything is right. I understand that people rely on their employers, banks, etc. to provide correct information, but in the end a person’s signature on IRS tax forms is stating “I certify that this information is correct.”

17

I agree, but if what I understand about this situation is accurate, the insurance company will be liable, and they have to know that. If they go to court, I would assume they would be sued for a lot more than just the money owed to this woman. She would sue them for any legal fees, and anything else an attorney would be legally able to tack on to the suit. I cannot believe they’d want to go that route, but who knows… If they think they can win, maybe they would be willing to do that.

This is not a lot of money to a large insurance company, but it is to her. And I would think that if the case has merit, the insurance company would know this and pay her, because ultimately, this decision will cost them less than dealing with attorneys (both their internal staff and the woman’s), court costs, and everything else associated with something like this.

They may be dragging their feet right now, but from my own POV, I just can’t understand how they would have a leg to stand on if it went to court. But since IANAL, and I am not a tax professional, my opinion can’t help her.

I am checking on this, and have a phone call in to a friend who would know this, but I believe the percentage of her income that is not taxable is an IRS regulation (or law), so if this is true, the insurance company didn’t just make a mistake on one employee with an employer who had a special policy… It is a federal law, and they screwed up their payments to her.

It would really suck if she has to give a lawyer a large percentage, but I guess if that is her only option, she would take that over getting zero back.

I personally think you are correct. Sadly, though, I have seen enough in my life to know that everything ultimately boils down to money. “Doing the right thing” never seems to be the choice anyone makes on their own… They have to be forced into it.

I know next to nothing anout the inner workings of the IRS, but in a case like this, I would like to think that once presented with the information, the IRS would say "ok… Insurance company, you are permitted to give this woman the corrected W-2’s. The money has already been paid to the government, so we will refund the money to the person. It was a mistake that was NOT the fault of the taxpayer, and the taxpayer will not be punished. Money is given back, and she gets on with her life.

Any fees or fines the government would deem appropriate would be charged to the insurance company.

I think this is probably the exact path this will take. For her sake, I hope we are both wrong.

I agree that a percentage of people would probably not pursue this for whatever reason, so the initial response of “we won’t pay” isn’t exactly surprising.

I don’t know much about her filing history, or if she asked for extensions. What I do know is that she was able to file amended returns for the past 3 years because she was sent the correct info on updated and amended W-2.

Just remembered this part… She had to pay for the preparation and filing of the amended tax forms, and said she received a letter from the insurance company that said they will pay a flat fee for each year, regardless of the actual cost. She has to submit a receipt for reimbursement, and no matter what she had to pay, the insurance company is only offering her what they feel is an appropriate amount. I guess they don’t want her to get someone to say it cost $1000 to file the amended returns. She said it cost her a little more than they will reimburse her, even though she has a receipt and again, is not at fault. I don’t remember the numbers, but IMO, she should not have had to pay a dime for the refiling, and that includes any travel expenses she incurred to get this done.

Indeed! Sadly, I am not exactly surprised this is the initial stance the insurance company took. Like anything, there is a financial motive here. And if this has happened only once or thousand times, their initial response will be the same. “Tell the person sorry, it’s an IRS law. Three years is their limit.”

Maybe a person is in a place financially where they don’t need the money, or more to the point, they don’t feel it is worth it to them to chase down the information needed to move the insurance company to pay. And my guess is, a percentage of people walk away without giving much of a fight. Even if only 10 people out of 100 don’t pursue it, that is money saved by the insurance company, and that goes to their bottom line.

I am confused on a lot of points, I am sure!

What I think happens is corporations use insurance companies to underwrite their disability policy. So, if a person is deemed to be legally disabled and can no longer work, the employee is compensated at a percentage of their annual salary. This seems to be the smart way to do it. Insurance companies work the numbers with their actuaries and come up with a premium for what the employer would have to pay in order to cover the employee in case something like this would occur.

In many ways it is the same way any insurance policy works. If you have auto insurance, you pay your premiums each month and hope you never have an accident. But if you do, you contact the insurance company and they pay whatever your coverage requires them to pay (i know it’s not always so easy).
Thanks all for your advice. I feel badly for this woman, and know this has and is continuing to cause her a lot of stress. I can’t offer direct help, but I am doing what I can for her, and asking folks out here was at least one thing I thought I could try.

If I find out any updates/changes that are relevant, I will post them.

Again, apologies for my lack of specific knowledge in some areas and my long-winded explanations on some things. This is not my area of expertise.

18

You both may be correct.

I am looking at this from a logical POV, but legally, there may be a SoL, and the insurance company is not legally liable.

I have no idea how someone would know what would or wouldn’t be open to taxation in a situation like this. She clearly didn’t know a portion of her income was not taxable. I suspect that if this wasn’t discovered, it may have continued to go on for the rest of her life.

And I agree that people “certify that this information is correct.” But if I remember my own form I signed this year, it said “to the best of my knowledge”. And shouldn’t the insurance company also be held to that standard?

I think an attorney will have to be involved. I know she has been looking for one, but I don’t know where she is in that process. I do know she has mobility/transportation issues, so she may not have been able to speak to someone in person yet.

I realize I am out of my depth here. Hopefully, she has found someone to give her the guidance she needs to navigate this.

Thanks all for your time.

19

I am wondering about this…

What kind of an attorney would be best for something like this?

A tax attorney sounds like the logical choice to me, but only on the surface. This will more than likely not be something that even involves the IRS, since as I understand it, it wasn’t their fault. The insurance company is the one who screwed the pooch here, so perhaps a tax attorney would not be the best choice.

Anyone have any ideas?

20

The IRS does not make up the tax code. Congress does. The job of the IRS is to enforce the tax law. It can make such regulations as Congress, through the tax code, delegates it authority.

While everyone might feel great sympathy toward your friend and agree it is no fault of her own, if the law does not grant the IRS the authority to make a refund, they cannot do it. Generally, the law grants the IRS authority to do so for a period of three years, with some specific exceptions and there may be some special rules about when the three-year period starts running. Unless you can identify a specific law that would grant them authority to extend the statute, appealing to their sense of fair play won’t get you anywhere.