Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca9-12-72985/USCOURTS-ca9-12-72985-0/pdf.json

Parties Involved:
Commissioner of Internal Revenue
Appellee
Frances Sewards
Appellant
Jay Sewards
Appellant

Document Text:

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

JAY AND FRANCES SEWARDS,

Petitioners-Appellants,

v.

COMMISSIONER OF INTERNAL

REVENUE,

Respondent-Appellee.

No. 12-72985

T.C. No.

24080-08

OPINION

Appeal from the United States Tax Court

Maurice B. Foley, Tax Court Judge, Presiding

Argued and Submitted

April 10, 2015—Pasadena, California

Filed May 12, 2015

Before: Barry G. Silverman and Carlos T. Bea, Circuit

Judges, and Gordon J. Quist, Senior District Judge.*

Opinion by Judge Quist

* The Honorable Gordon J. Quist, Senior District Judge for the U.S.

District Court for the Western District of Michigan, sitting by designation.

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2 SEWARDS V. CIR

SUMMARY**

Tax

The panel affirmed the Tax Court’s denial of a petition for

redetermination of a 2006 federal income tax deficiency

based on the failure to report disability retirement payments.

Income is excluded from taxation under 26 U.S.C.

§ 104(a)(1) if it is received under workmen’s compensation

acts as compensation for personal injuries or sickness. 

Taxpayer retired due to a service-connected disability and

received a disability pension equal to one-half his previous

salary. Based on his years of service, he received an

additional amount to bring his pension up to what he would

have received as a service pension. The panel held that this

additional amount was taxable because it was paid not based

on taxpayer’s injuries, but based on his years of service.

COUNSEL

Marshall W. Taylor (argued), Taylor, Simonson & Winter,

LLP, Claremont, California, for Petitioner-Appellant.

Kathryn Keneally, Assistant Attorney General, Robert

Metzler (argued), and Melissa Briggs, Tax Division,

Department of Justice, Washington, D.C., for RespondentAppellee.

** This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.

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SEWARDS V. CIR 3

OPINION

QUIST, Senior District Judge:

This case involves the taxation of retirement payments

made to Jay Sewards, a former employee of the Los Angeles

County Sheriff’s Department. Like all County employees

who retire with a service-connected disability, Sewards was

entitled to receive a disability pension equal to one-half his

previous salary. Because Sewards had completed 34 years of

service, however, he received an additional amount to bring

his pension up to what he would have received as a service

pension. The question presented in this case is whether that

additional amount is taxable under the Internal Revenue

Code. Sewards argues that the entire amount of the

retirement allowance may be excluded from taxation because

it is a worker’s compensation pension.

1 The Tax Court

rejected Sewards’s argument, concluding that the portion of

Sewards’s retirement allowance exceeding what he would

have received solely based on disability is subject to taxation. 

Sewards now appeals that ruling. We have jurisdiction under

26 U.S.C. § 7482(a)(1), and we affirm the judgment of the

Tax Court.

I.

The Los Angeles County Employees Retirement

Association (LACERA) manages retirement assets and

payments for retired Los Angeles County employees. Los

Angeles County employees who sustain service-connected

1 Although the payments at issue were made to Jay Sewards, his wife is

also a party to the case because they are joint taxpayers. For purposes of

clarity, however, this Opinion will refer only to Mr. Sewards.

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4 SEWARDS V. CIR

injuries may retire on account of a service-connected

disability. Cal. Gov’t Code § 31720. The California statute

that governs payments for employees who retire with a

service-connected disability provides:

[The employee] shall receive an annual

retirement allowance payable in monthly

installments, equal to one-half of his final

compensation. Notwithstanding any other

provisions of this chapter, any member upon

retirement for service-connected disability

shall receive a current service pension or a

current service pension combined with a prior

service pension purchased by the

contributions of the county or district

sufficient which when added to the service

retirement annuity will equal one-half of his

final compensation, or, if qualified for a

service retirement, he shall receive his service

retirement allowance if such allowance is

greater . . . .

Cal. Gov’t Code § 31727.4. An individual’s service

retirement allowance is calculated using a statutory formula

based on the individual’s final salary, years of service, and

age at retirement. Cal. Gov’t Code § 31664.

Sewards worked for the Los Angeles County Sheriff’s

Department until November 29, 2000, when he was placed on

involuntarymedical disability leave due to service-connected

injuries. While on disability leave, Sewards received his

$14,093 per month salary. After exhausting his disability

leave, Sewards applied for and received a service retirement

allowance based on his 34 years of service. After it became

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SEWARDS V. CIR 5

clear that his injuries were permanent, however, Sewards

applied for and received a service-connected disability

retirement allowance. Sewards received the amount of his

service retirement allowance because it was greater than onehalf his final salary.

In each year from 2001 through 2005, LACERA sent

Sewards a Form 1099-R indicating that the taxable amount of

his retirement allowance was not determined; as a result,

Sewards paid no tax on the pension. In 2006, LACERA sent

Sewards a 1099-R indicating that a portion of his retirement

allowance was taxable. Sewards did not, however, report as

taxable any of the income from his retirement allowance on

his 2006 tax return. The IRS subsequently issued a notice of

deficiency, and Sewards filed a petition with the Tax Court. 

The Tax Court, considering the petition on the basis of

stipulated facts, held that the portion of Sewards’s pension

that exceeded one-half his final salary was taxable.

II.

We review the Tax Court’s interpretation of the Internal

Revenue Code and its legal conclusions de novo. Teruya

Bros., Ltd. v. Comm’r, 580 F.3d 1038, 1043 (9th Cir. 2009). 

The application of law to a stipulated factual record is also

reviewed de novo. Samueli v. Comm’r, 661 F.3d 399, 407

(9th Cir. 2011).

III.

A.

Gross income includes “all income from whatever source

derived.” 26 U.S.C. § 61(a). “An accession to wealth . . . is

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6 SEWARDS V. CIR

presumed to be taxable income, unless the taxpayer can

demonstrate that it fits into one of the Tax Code’s specific

exemptions.” Hawkins v. United States, 30 F.3d 1077, 1079

(9th Cir. 1994). Section 104(a)(1) of the Internal Revenue

Code specifically excludes from taxation “amounts received

under workmen’s compensation acts as compensation for

personal injuries or sickness.” 26 U.S.C. § 104(a)(1). 

Treasury Regulation §1.104-1(b) provides:

Section 104(a)(1) excludes from gross income

amounts which are received by an employee

under a workmen’s compensation act . . . or

under a statute in the nature of a workmen’s

compensation act which provides

compensation to employees for personal

injuries or sickness incurred in the course of

employment. . . . However, section 104(a)(1)

does not apply to a retirement pension or

annuity to the extent that it is determined by

reference to the employee’s age or length of

service, or the employee’s prior contributions,

even though the employee’s retirement is

occasioned by an occupational injury or

sickness.

Treas. Reg. § 1.104-1(b).

The Commissioner agrees that the California statute

authorizing Sewards’s retirement allowance is in the nature

of aworkmen’s compensation act. The Commissioner further

agrees that the portion of Sewards’s retirement allowance that

represents one-half of Sewards’s final salary is excludable

from taxation as a service-connected disability payment. The

Commissioner argues, however, that the amount that

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SEWARDS V. CIR 7

represents the difference between one-half of Sewards’s final

salary and his service retirement allowance is subject to

taxation pursuant to Treasury Regulation § 1.104-1(b). 

Sewards responds that the regulation does not apply to the

payments at issue, and that if it does, the regulation exceeds

the scope of the statute and is invalid.

B.

There is no dispute that Sewards’s retirement allowance

is calculated with reference to his years of service. Sewards

argues, however, that this fact does not bring the payments

within the limitation in Treasury Regulation §1.104-1(b)

because Sewards was eligible for retirement, and received

any pension at all, solely because of his service-connected

disability. The limitation in the regulation, he argues, applies

only where an individual qualified for a retirement allowance

based on years of service, rather than because of a serviceconnected disability. Under Sewards’s reading of the

regulation, a retiree may exclude the entire allowance

pursuant to § 104(a) so long as he retired because of a

service-connected disability, even if his retirement payments

are calculated based on his age or years of service. On the

other hand, the Commissioner argues that the limitation

applies when an individual who retires with a serviceconnected disability receives an allowance amount that is at

least in part based on his years of service.

Treasury Regulation §1.104-1(b) “limits the scope of

§ 104(a)(1)” by specifying that the workmen’s compensation

exclusion “does not apply to a retirement pension to the

extent that it is determined by reference to the employee’s

age and length of service.” Picard v. Comm’r, 165 F.3d 744,

745 (9th Cir. 1999) (internal quotation marks omitted). Thus,

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whether retirement benefits “are excludable from gross

income depends on whether the [the relevant statute]

determines [the taxpayer’s] benefits by reference to his length

of service.” Id.

As noted, Sewards argues that an individual’s benefit is

determined by age or length of service onlywhen such factors

are used to decide whether the individual qualifies for

retirement, but not when such factors are used to calculate the

amount of the benefit. In our judgment, however, Sewards’s

interpretation is not supported by the text of the regulation. 

Rather, the interpretation advocated by the Commissioner

aligns with the most natural reading of the regulation.

Moreover, the interpretation advocated by the

Commissioner in this case is consistent with the interpretation

adopted by the IRS in Revenue Rulings issued over the last

40 years. In Revenue Ruling 72-44, the IRS examined a

Louisiana statute that provided disability payments for

firefighters injured in the line of duty. Rev. Rul. 72-44, 1972-

1 C.B. 32. Like the California statute at issue in this case, the

Louisiana statute provided for a firefighter to receive a

disability pension equal to the greater of one-half his salary

or the amount of his service pension. Id. The IRS concluded

that an individual’s payments were excludable from taxation

only to the extent that they did not exceed one-half of the

individual’s salary. Id. The IRS examined a similar statute

in Revenue Ruling 80-44 and reached the same conclusion. 

Rev. Rul. 80-44, 1980-1 C.B. 34.

The IRS’s consistent interpretation of Treasury

Regulation §1.104-1(b) through Revenue Rulings is entitled

to deference. As the Supreme Court has explained:

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SEWARDS V. CIR 9

[Revenue]Rulings simply reflect the agency’s

longstanding interpretation of its own

regulations. Because that interpretation is

reasonable, it attracts substantial judicial

deference. . . . Treasury regulations and

interpretations long continued without

substantial change, applying to unamended or

substantially reenacted statutes, are deemed to

have received congressional approval and

have the effect of law.

United States v. Cleveland Indians Baseball Co., 532 U.S.

200, 220 (2001) (internal citations and quotation marks

omitted). The IRS’s long-standing interpretation of Treasury

Regulation §1.104-1(b) through Revenue Rulings is

reasonable, and thus entitled to substantial deference.

Finally, the Tax Court cases that Sewards cites fail to

demonstrate that the IRS’s consistent interpretation of

Treasury Regulation §1.104-1(b) is at odds with its text. 

Unlike the retirement payments at issue in this case, the

payments in those cases were calculated without reference to

the retirees’ years of service. Byrne v. Comm’r, 84 T.C.M.

704 (2002) (concluding that disability payments calculated

without reference to years of service were not taxable);

Givens v. Comm’r, 90 T.C. 1145 (1988) (concluding that

payments for on-the-job injuries labeled as “sick pay”

qualified for exclusion). Thus, the decisions in those cases

provide little insight into the issue presented here.

The text of Treasury Regulation §1.104-1(b) and the

consistent interpretation of that text by the IRS demonstrate

that it applies to retirement payments that are calculated with

reference to an employee’s age or length of service. 

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Accordingly, Sewards’s argument that the payments at issue

fall outside the limitation in that regulation fails.

C.

Sewards argues that, if Treasury Regulation §1.104-1(b)

is interpreted to apply to payments that are calculated with

reference to an employee’s age or length of service, it is

invalid, because that reading is inconsistent with § 104(a)(1)

and beyond the scope of the agency’s rulemaking authority.

The Treasury Department has authority to issue “all

needful rules and regulations for the enforcement of [the

Internal Revenue Code.].” 26 U.S.C. § 7805(a). To

determine whether a Treasuryregulation is valid, courts apply

the two-step analysis announced in Chevron, U.S.A., Inc. v.

Natural Res. Def. Council, Inc., 467 U.S. 837, 842–43 (1984).

Mayo Found. for Med. Educ. & Research v. United States,

562 U.S. 44, 52 (2011). First, the court must determine

“whether Congress has ‘directly addressed the precise

question at issue.’” Id. (quoting Chevron, 467 U.S. at 842). 

If Congress has not done so, the court must determine

whether the rule is “a ‘reasonable interpretation’ of the

enacted text.” Id. at 58 (quoting Chevron, 467 U.S. at 844). 

An express congressional grant of authority to issue rules and

regulations, like that found in 26 U.S.C. § 7805(a), is “‘a very

good indicator of delegation meriting Chevron treatment.’” 

Id. at 57 (quoting United States v. Mead Corp., 533 U.S. 218,

229 (2001)).

Section 104(a)(1) provides that workmen’s compensation

payments for injury or sickness are excludable, but leaves

open the question of how to determine whether a payment is

made for injury or sickness, as opposed to some other reason. 

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Thus, Congress has not directly addressed the precise

question at issue—namely, the tax treatment of payments

that, while triggered by work-related injury or sickness, are

calculated based on years of service. Accordingly, the first

step of the Chevron analysis is satisfied.2

Treasury Regulation § 1.104-1(b) is a reasonable

interpretation of § 104(a)(1). As the Sixth Circuit explained:

“Section 104(a)(1) is designed to exclude disabilitypayments,

not pension payments, from income. Treas. Reg. § 1.104(b)

[the prior version of Treasury Regulation § 1.104-1(b)]

simply identifies what is a pension payment and distinguishes

it from a disability payment.” Wiedmaier v. Comm’r,

774 F.2d 109, 111 (6th Cir. 1985). The regulation does not,

as Sewards argues, create a subclass of disability pension

recipients. Rather, the regulation simply clarifies when a

payment is made for personal injuries or sickness, and when

2 Our court’s decision in Take v. Comm’r, 804 F.2d 553 (9th Cir. 1986)

(Kennedy, J.), does not bar us from concluding that the statute is

ambiguous as to the tax treatment of those payments which, though under

a workmen’s compensation statute, are not calculated by reference to the

extent of the worker’s disability. In Take, we held that the disability

pension statute of Anchorage, Alaska, which established an irrebuttable

presumption that “heart, lung, and respiratory system illnesses” suffered

by firefighters would be presumed to be occupational disabilities, was not

a workmen’s compensation act. Id. at 555. We explained that “[s]tatutes

that do not restrict the payment of benefits to cases of work-related injury

or sickness are not considered to be ‘workmen's compensation acts’ under

section 104.” Id. at 557 (emphasis added). Thus, Take holds that for a

statute to count as a workmen’s compensation act, every worker paid

pursuant to that statute must have suffered a disability. Take does not

hold, however, that every dollar paid to those workers must have been

paid on account of that disability. Sewards’s argument to the contrary is

incorrect.

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it is made for some other reason, such as years of service. 

Accordingly, the regulation is consistent with the statute.

In short, the question of how to differentiate between

payments made to a employee as compensation for a

workplace injury from those made for some other purpose is

not answered by § 104(a)(1). Because the Treasury

Department’s rule is a reasonable interpretation of that

statute, it is within the scope of the agency’s delegated

authority.

IV.

“[T]he fundamental question in determining whether

benefits are excludable under § 104(a) is upon what basis

were the retirement payments in question paid?” Picard,

165 F.3d at 746 (internal quotation marks omitted). Like any

other County employee who retired with a service-connected

disability, Sewards was entitled to receive one-half his final

salary based on his injuries. That amount was excludable. 

Because Sewards had completed 34 years of service,

however, he received additional amounts so that, in

accordance with the state statute, his service-connected

disability pension was the same as what he would have

received as a service pension. Those additional amounts were

paid not based on his injuries, but based on his years of

service, and thus were not excludable.

For the foregoing reasons, the Tax Court’s decision is

AFFIRMED.

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