The opinion
T.C. Summary Opinion 2009-131
UNITED STATES TAX COURT
JEREMIAH FRANCIS O’NEILL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6708-08S. Filed August 25, 2009.
Jeremiah Francis O’Neill, pro se.
Joan M. Casali, for respondent.
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for the
taxable years in issue.
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other court, and this opinion shall not be treated as precedent
for any other case.
Petitioner received a notice of deficiency for 2004, 2005,
and 2006 in which respondent determined: (1) Deficiencies in
income taxes of $5,894, $6,146, and $6,313, respectively, and (2)
accuracy-related penalties under section 6662(a) for substantial
understatement of income tax of $1,179, $1,229, and $1,263,
respectively. The issues for decision are: (1) Whether
petitioner may exclude from gross income payments received from
the New York City Fire Department Pension Fund; and (2) whether
petitioner is liable for the accuracy-related penalty under
section 6662(a) for each of the years at issue. We hold that
petitioner may not exclude said payments and that he is not
liable for the penalties.
Background
Some of the facts have been stipulated, and they are so
found. We incorporate by reference the parties’ stipulation of
facts and accompanying exhibits.
When the petition was filed, petitioner resided in the State
of New York.
From January 1955 until May 1976 petitioner was employed by
the City of New York. Petitioner began his tenure with the City
of New York as a police officer, but after 2 years he transferred
to the fire department, where he served as a firefighter for the
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remaining 19 years. At the time petitioner transferred to the
fire department, the New York City Fire Department, Article 1-B
Pension Fund (Pension Fund) assumed liability for any retirement
earnings he had accumulated as a police officer. See N.Y. City
Admin. Code secs. 13-301 through 13-379.1 (2009). The Pension
Fund required members to contribute a specified amount through
payroll deductions determined by the member’s age at appointment.
Upon the member’s 20th anniversary these mandatory contributions
ceased. During the course of his employment with the City of New
York, petitioner contributed $5,894.46 to the Pension Fund.
In addition to the mandatory member contributions, the City
of New York contributed a small amount on behalf of each member
as well as an additional larger amount to maintain the overall
integrity of the Pension Fund. The Pension Fund did not maintain
separate member accounts and did not distinguish between employer
and employee contributions with respect to the categories of
retirement. Instead, the Pension Fund pooled all of the
contributions into a contingency reserve fund.
The Pension Fund provided three categories of retirement:
Regular service, ordinary disability, and accidental disability.
The amount of benefit received depended upon the category under
which the member retired.
Regular service retirement was available to all members
after 20 years of service, regardless of the member’s age, and
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the benefit was determined on the basis of the member’s final
compensation and years of service. A member could continue in
service after the 20 years, but had to retire by the age of 65.
Ordinary disability retirement was available when the member
became physically or mentally incapacitated from the performance
of duty as a result of a non-service-incurred disability. The
Pension Fund determined the amount of benefit on the basis of the
member’s final compensation and number of years of service.
Accidental disability retirement was available when a member
became physically or mentally incapacitated from the performance
of service as a result of a service-incurred disability. The
amount of benefit was equal to three-quarters of the member’s
final compensation. In the case of both ordinary and accidental
disability retirement, the nature and severity of the injury did
not determine the amount of benefit that the retiring member
received.
Petitioner received ordinary disability retirement from the
Fire Department commencing in 1976. At trial petitioner
explained the nature of his disability, stating that while
serving in the Armed Forces during the Korean War he injured his
hand and that this injury left him more susceptible to injuring
his foot when mounting and dismounting a fire truck.
After considering petitioner’s condition, the New York City
Fire Department’s Bureau of Accounts and Procurement recommended
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that petitioner be granted ordinary disability retirement. As a
result, on May 28, 1976, the Board of Trustees of the Pension
Fund directed the retirement of petitioner for a “Non-Service
Incurred Disability” with a retirement date of May 29, 1976.
In 2004, 2005, and 2006, petitioner received payments from
the Pension Fund of $34,323.96, $34,539.96, and $34,833.96,
respectively. Petitioner did not report these amounts on his
returns for those years. It was (and still is) petitioner’s
position that these payments were tax-free pension insurance
payments received as a result of his premium payments of
$5,894.46 made during his tenure with the City of New York.
Discussion
A. Includability of Pension Fund Payments
Section 61(a) provides generally that “gross income means
all income from whatever source derived”. Gross income is an
inclusive term with broad scope, designed by Congress to “exert
* * * ‘the full measure of its taxing power.’” Commissioner v.
Glenshaw Glass Co., 348 U.S. 426, 429 (1955) (quoting Helvering
v. Clifford, 309 U.S. 331, 334 (1940)). Section 61 specifically
includes annuities and pensions as items of gross income. Sec.
61(a)(9), (11).
Statutory exclusions from income are matters of legislative
grace and are narrowly construed. Commissioner v. Schleier, 515
U.S. 323, 328 (1995). Taxpayers seeking an exclusion from income
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must demonstrate they are eligible for the exclusion and bring
themselves “within the clear scope of the exclusion.” Dobra v.
Commissioner, 111 T.C. 339, 349 n.16 (1998).
The taxation of disability retirement benefits, such as
those paid to petitioner under the Pension Fund, requires
examination of sections 72, 104, and 105, and the regulations
thereunder.
Section 72(a) generally includes in gross income any amount
received as an annuity under an annuity, endowment, or life
insurance contract. Section 72(b) provides an exclusion from
gross income of an amount proportionate to the taxpayer’s
investment in the contract limited to the taxpayer’s unrecovered
investment in the contract. Section 72(c) defines the investment
in the contract as the aggregate amount of premiums or other
consideration paid for the contract.
If petitioner’s disability retirement benefits are
considered received under an annuity, endowment, or life
insurance contract, the general rule includes the amounts
received in gross income, but section 72(b) excludes a portion on
the basis of petitioner’s investment in the contract. However,
for taxpayers whose annuity starting date was on or before July
1, 1986, section 72(d) provided a 3-year basis recovery rule.2
2
This provision was repealed by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1122(c)(1), (h)(1)-(7), 100 Stat.
(continued...)
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Under this provision, if the taxpayer would recover his total
contribution in the first 3 years of his annuity, then he could
exclude all amounts received under the contract until there had
been so excluded an amount equal to the taxpayer’s contribution.
All amounts received thereafter would be includable in gross
income. Id.
Petitioner retired in 1976, and although it is unclear what
amount, if any, he received in 1976, he received disability
retirement benefits in 1977 of $17,303.04. Because the amount
received in 1977 exceeded petitioner’s total contributions of
$5,894.46 and was within the 3-year period, he was eligible to
exclude his contributions to the Pension Fund from his taxable
income for taxable year 1977. All subsequent payments were to be
included in petitioner’s gross income.
B. Exclusion Provisions of Sections 104 and 105
Section 72 applies to “a pension plan * * * which provides
for the payment of pensions at retirement and the payment of an
earlier pension in the event of permanent disability.” Sec.
1.72-15(a), Income Tax Regs. However, section 72 does not apply
to any amount received as an accident or health benefit, and the
tax treatment of any such amount is determined under sections 104
2
(...continued)
2467, 2470, as amended by the Technical and Miscellaneous Revenue
Act of 1988, Pub. L. 100-647, sec. 1011A(b)(2)(A), (12)-(15) 102
stat. 3472, 3474.
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and 105. Sec. 1.72-15(b), Income Tax Regs. Thus, generally
speaking, “the framework established under section 72 applies
where no exclusion is available under section 104 or 105.”
Wright v. Commissioner, T.C. Memo. 2005-5. We turn therefore to
the exclusions provided by sections 104 and 105.
Section 104(a), in relevant part, excludes from gross income
certain amounts received as compensation for injuries or sickness
described in paragraphs (1) through (4).3 Section 105(a)
includes in gross income certain amounts received under accident
and health plans for personal injuries or sickness, subject to
two exceptions.
Although petitioner argues that his disability retirement
benefits are excludable from income, the record clearly
establishes that the amounts he received do not qualify for any
of the exclusions of sections 104 and 105.
Section 104(a)(1) excludes from gross income “amounts
received under workmen’s compensation acts as compensation for
personal injuries or sickness”. However, section 104(a)(1) “does
not apply to amounts which are received as compensation for
nonoccupational injury or sickness”. Sec. 1.104-1(b), Income Tax
Regs. Thus, a statute will not be considered a workmen’s
compensation act if it allows for disability payments for reasons
3
Par. (5) of sec. 104(a), which applies to victims of
terrorist attacks, is on its face inapplicable to the facts
before us.
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other than service-incurred injuries. Haar v. Commissioner, 78
T.C. 864, 868 (1982) (citing Riley v. United States, 140 Ct. Cl.
381, 156 F. Supp. 751 (1957)), affd. 709 F.2d 1206 (8th Cir.
1983).
The Pension Fund established by the Administrative Code of
the City of New York provided disability payments for both
service- and non-service-incurred injuries. The resolution
adopted by the Board of Trustees of the Pension Fund on May 28,
1976, awarded retirement benefits to petitioner on account of a
non-service-incurred disability. These benefits are, therefore,
not excludable from gross income under section 104(a)(1).
Section 104(a)(2) excludes from gross income damages
“received (whether by suit or agreement * * *) on account of
personal physical injuries or physical sickness”. “The term
‘damages received (whether by suit or agreement)’ means an amount
received * * * through prosecution of a legal suit or action
based upon tort or tort type rights, or through a settlement
agreement entered into in lieu of such prosecution.” Sec. 1.104-
1(c), Income Tax Regs. Thus, “The essential element of an
exclusion under 104(a)(2) is that the income involved must derive
from some sort of tort claim against the payor.” Glynn v.
Commissioner, 76 T.C. 116, 119 (1981), affd. without published
opinion 676 F.2d 682 (1st Cir. 1982).
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The ordinary disability retirement benefits provided under
the Pension Fund were not payments derived from a tort claim
against the City of New York. Rather, such payments were made to
petitioner as a result of a prior employment relationship with
the City and were calculated on the basis of his years of service
and final compensation. Consequently, the benefits petitioner
received are not excludable from gross income under section
104(a)(2).
Section 104(a)(3) generally excludes from gross income
amounts received by an employee through employer-provided
accident or health insurance for personal injuries or sickness.
This exclusion does not apply if the amounts received are
attributable to employer contributions that were not includable
in the gross income of the employee, or were paid by the
employer. Id. If an employer and his employees contribute to a
fund or purchase insurance that pays accident or health benefits
to employees, section 104(a)(3) does not apply to amounts
received thereunder to the extent that such amounts are
attributable to the employer’s contributions. Sec. 1.104-1(d),
Income Tax Regs. “[I]n the case of a retirement plan to which an
employee is required to contribute, it is presumed that the
accident and health benefits are funded by employer
contributions.” Bagnell v. Commissioner, T.C. Memo. 1993-378
(citing Chosiad v. Commissioner, T.C. Memo. 1980-408). Moreover,
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unless the plan expressly provides otherwise, the law presumes a
contributing plan that provides both disability and retirement
benefits sources the disability benefits in employer
contributions. Id.
The Pension Fund required petitioner to contribute, provided
both disability and retirement benefits, and contained no express
provision on the source of the disability benefits. Therefore,
the benefits received by petitioner are not excludable under
section 104(a)(3).
Section 105 is the mirror image to section 104(a)(3) but
provides two exceptions to includability. Section 105(b)
provides an exclusion for amounts paid by an employer to the
taxpayer to reimburse the taxpayer for expenses for medical care.
Medical expenses are not at issue in this case, so the exception
in section 105(b) does not apply.
Section 105(c) excludes from gross income amounts
attributable to employer contributions to the extent such amounts
(1) constitute “payment for the permanent loss or loss of use of
a member or function of the body, or the permanent disfigurement,
of the taxpayer, * * * and (2) are computed with reference to the
nature of the injury without regard to the period the employee is
absent from work.” Courts have interpreted section 105(c) to
exclude payments from gross income only if the plan or contract
under which such payments are made varies the amount of the
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payments according to the type and severity of the injury
suffered by the employee. Beisler v. Commissioner, 814 F.2d
1304, 1307 (9th Cir. 1987), affg. T.C. Memo. 1985-25.
The Pension Fund’s computation of an ordinary disability
retirement benefit did not vary with the nature of the
disability. Instead, the Pension Fund determined the member’s
benefit on the basis of final compensation and years of service.
Thus, the exception under section 105(c) does not apply.
Returning now to section 104, subsection (a)(4) excludes
from gross income amounts received for injuries or sickness
resulting from active service in the Armed Forces. Determining
whether the injury or sickness resulted from active service in
the Armed Forces requires examining the underlying provision upon
which the benefits are predicated. Haar v. Commissioner, supra
at 866. If the provisions consider solely the employee’s ability
to perform his or her job, and the nature or cause of the injury
is irrelevant, then whether the injury arose in military service
is simply not a factor. Id. at 866-867.
Although petitioner incurred an injury while serving in the
Korean War that contributed to the later injury of his foot, the
ordinary disability retirement provision of the Pension Fund
considered only his ability to perform the duties of a
firefighter. Therefore, the nature or cause of the injury was
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irrelevant, and petitioner does not satisfy the requirements of
section 104(a)(4).
On the basis of foregoing, petitioner is not entitled to
exclude from gross income the ordinary disability retirement
benefits he received from the New York City Fire Department,
Article 1-B Pension Fund. Accordingly, we hold that the ordinary
disability retirement benefits petitioner received in 2004, 2005,
and 2006 constitute gross income for each year.
C. Section 6662(a) Penalty
Section 6662(a) and (b)(2) imposes a penalty equal to 20
percent of the amount of any underpayment attributable to a
substantial understatement of income tax. An understatement of
income tax is substantial if the understatement exceeds the
greater of 10 percent of the tax required to be shown on the
return or $5,000. Sec. 6662(d)(1)(A). The definition of
understatement for this purpose is the excess of the tax required
to be shown on the return over the tax actually shown on the
return. Sec. 6662(d)(2)(A).
Tax is not understated to the extent that (1) the taxpayer
bases treatment of the item on substantial authority, or (2) the
taxpayer adequately discloses the item in the return or in a
statement attached to the return and the taxpayer has a
reasonable basis for the tax treatment of such item. Sec.
6662(d)(2)(B). Further, the penalty is inapplicable with respect
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to any part of an underpayment if it is shown that there was
reasonable cause for such position and that the taxpayer acted in
good faith with respect to such position. Sec. 6664(c)(1). The
Commissioner bears the burden of production, sec. 7491(c), but,
if satisfied, the taxpayer then bears the ultimate burden of
persuasion, Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
Although the issue is a close one, we are satisfied, after
considering the totality of the facts and circumstances, that
petitioner acted in good faith and comes within the reasonable
cause exception of section 6664(c)(1). Accordingly, we hold that
petitioner is not liable for the accuracy-related penalties.
Conclusion
We have considered all of the arguments made by petitioner,
and, to the extent that we have not specifically addressed them,
we conclude that they are without merit.
To reflect the foregoing,
Decision will be entered
for respondent as to the
deficiencies in taxes and for
petitioner as to the accuracy-
related penalties.