J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

34.4 Election for Lump-Sum Social Security Benefit Payment

If in 2012 you receive a lump-sum payment of benefits covering prior years, you have a choice as to how to determine the taxable portion of the benefits: (1) You may treat the entire payment as a 2012 benefit taxable under the rules in the preceding section (34.3) or (2) you may allocate the benefits between 2012 and the earlier years. Choose the method that provides the lowest required increase to income in the current year. For example, if you receive a 2012 lump-sum payment that includes benefits for 2011, you may find that an allocation of benefits is advantageous where your income over the two-year period has fluctuated and benefits allocated to 2011 would be subject to a lower taxable percentage than in 2012.

When you elect to allocate benefits to a prior year, you do not amend the return for that year. You compute the increase in income (if any) that would have resulted if the Social Security benefits had been received in that year. You then add that amount to the income of the current year.

See IRS Publication 915 for instructions and worksheets for making the allocation and figuring the amount to be reported on your return.