Court Opinion

ID: 4339071
Source: CourtListenerOpinion
Date Created: 2018-11-14 04:13:59.035318+00
Date Added: 2024-06-11T07:49:38.336789
License: Public Domain

JAY SEWARDS AND FRANCES SEWARDS, PETITIONERS
                                                    v. COMMISSIONER OF INTERNAL REVENUE,
                                                                 RESPONDENT
                                                        Docket No. 24080–08.                           Filed April 2, 2012.

                                                  P–H received disability retirement payments relating to
                                                injuries suffered in the course of his employment. The pay-
                                                ment amount was determined, in part, by reference to P–H’s
                                                length of service. Ps did not report any portion of the pay-
                                                ments as taxable. Held: Pursuant to I.R.C. sec. 104(a)(1), the
                                                portion of P–H’s disability retirement payments determined
                                                by reference to his length of service is not excludable from
                                                income. See sec. 1.104–1(b), Income Tax Regs. Held, further,
                                                Ps are not liable for an accuracy-related penalty.

                                           Marshall West Taylor, for petitioners.
                                           Scott B. Burkholder, for respondent.

                                                                                   OPINION

                                         FOLEY, Judge: The issues for decision, relating to peti-
                                      tioners’ 2006 joint Federal income tax return, are whether
                                      petitioners may exclude certain retirement payments from
                                      income and whether petitioners are liable for a section
                                      6662(a) 1 accuracy-related penalty. The parties submitted this
                                      case fully stipulated pursuant to Rule 122.
                                        1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect

                                      for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Proce-

                                      320

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                                      (320)                         SEWARDS v. COMMISSIONER                                           321

                                                                                Background
                                        On November 29, 2000, after many years of employment
                                      with the Los Angeles County Sheriff’s Department (Sheriff’s
                                      Department), and because of service-connected injuries, Jay
                                      Sewards was placed on involuntary medical disability leave.
                                      While on disability leave, he was provided a continuation of
                                      his $14,093 per month salary (final compensation) for one
                                      year. Because he suffered his service-connected injury after
                                      more than 34 years of employment with the Sheriff’s Depart-
                                      ment, Mr. Sewards was eligible for two types of retirement
                                      plans: a service retirement based on his length of service
                                      (service retirement) and a service-connected disability retire-
                                      ment based on his service-connected injuries (SCD retire-
                                      ment).
                                        On an election form dated July 30, 2001, Mr. Sewards
                                      requested, and the Los Angeles County Employees Retire-
                                      ment Association (LACERA) 2 granted, a service retirement to
                                      take effect upon the expiration of his disability leave on
                                      October 31, 2001. 3 Service retirement was authorized for
                                      individuals who: had completed 20 years of service regardless
                                      of age; had attained the applicable compulsory age of retire-
                                      ment; 4 or had attained the age of 50, completed 10 years of
                                      service, and had no break from service which exceeded 12
                                      months. California County Employees Retirement Law of
                                      1937 (CERL) sec. 31663.26. 5 The amount of Mr. Sewards’
                                      service retirement payment was determined, by reference to
                                      his length of service, 6 to be $12,861 per month. 7
                                        On May 28, 2002, Mr. Sewards applied for and was
                                      granted SCD retirement retroactive to the date upon which
                                      his service retirement took effect. Thus, his SCD retirement
                                      replaced his service retirement. Individuals were eligible for
                                      dure.
                                         2 LACERA was the legally constituted agency for management of retirement assets and pay-

                                      ments to Los Angeles County employees.
                                         3 His service retirement was originally approved to take effect on October 9, 2001, but upon

                                      Mr. Sewards’ request, his service retirement became effective immediately upon the expiration
                                      of his disability leave.
                                         4 The compulsory retirement age varied depending on the individual’s job title. See Cal. Govt.

                                      Code secs. 31662.4–31663 (West 2008).
                                         5 CERL is codified in Cal. Govt. Code secs. 31450–31898 and adopted into L.A. County Code

                                      secs. 5.20.010–5.20.080.
                                         6 Mr. Sewards acquired service credit for each payroll period of county employment during

                                      which a retirement contribution was made.
                                         7 In subsequent years, this amount was increased to take into account cost of living adjust-

                                      ments.

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                                      322                 138 UNITED STATES TAX COURT REPORTS                                     (320)

                                      SCD   retirement if they were permanently incapacitated
                                      because of an injury or disease arising from their county
                                      employment. Id. secs. 31720, 31727.4. The SCD retirement
                                      plan would provide him with one-half of his final compensa-
                                      tion (i.e., $7,046) or his full service retirement allowance (i.e.,
                                      $12,861), whichever was higher. Id. sec. 31727.4. Thus, Mr.
                                      Sewards received his full service retirement allowance of
                                      $12,861 per month.
                                         LACERA sent Mr. Sewards 2001 and 2002 Forms 1099–R,
                                      Distributions From Pensions, Annuities, Retirement or
                                      Profit-Sharing Plans, IRAs, Insurance Contracts, etc., indi-
                                      cating that his service retirement payments were taxable.
                                      After his SCD retirement became effective, LACERA sent him
                                      amended 2001 and 2002 Forms 1099–R which indicated that
                                      the taxable amount was not determined. LACERA later sent
                                      him 2003, 2004, and 2005 Forms 1099–R which also
                                      indicated that the taxable amount was not determined. In a
                                      letter dated December 20, 2006, LACERA notified Mr. Sewards
                                      that beginning in 2006 it would report as taxable 50% of his
                                      final compensation. Consistent with the letter, LACERA sent
                                      him a 2006 Form 1099–R indicating a portion of his SCD
                                      retirement payments was taxable.
                                         On their joint 2006 Federal income tax return, petitioners
                                      did not report any portion of Mr. Sewards’ SCD retirement
                                      payments as taxable. Respondent subsequently issued a
                                      statutory notice of deficiency determining that a portion of
                                      his SCD retirement payments was taxable and that peti-
                                      tioners were liable for a section 6662(a) accuracy-related pen-
                                      alty. On October 1, 2008, petitioners, while residing in Port
                                      Ludlow, Washington, filed their petition with the Court.

                                                                                 Discussion
                                         Section 104(a)(1) and the regulations thereunder provide
                                      that retirement payments are excludable from gross income
                                      if they are received pursuant to a workmen’s compensation
                                      act or a statute in the nature of a workmen’s compen-
                                      sation act. Sec. 1.104–1(b), Income Tax Regs. Section
                                      104(a)(1) does not apply, however, to the extent the pay-
                                      ments are determined by reference to the employee’s age or
                                      length of service or the employee’s prior contributions, even

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                                      (320)                         SEWARDS v. COMMISSIONER                                           323

                                      if the employee’s retirement is occasioned by occupational
                                      injury. Sec. 1.104–1(b), Income Tax Regs.
                                         The statute authorizing payments to Mr. Sewards is in the
                                      nature of a workmen’s compensation act 8 and Mr. Sewards
                                      suffered an injury which arose in the course of his employ-
                                      ment. See Givens v. Commissioner, 90 T.C. 1145 (1998); sec.
                                      1.104–1(b), Income Tax Regs. Thus, in order to determine
                                      whether his SCD retirement payments are excludable, we
                                      must examine whether the amounts received were deter-
                                      mined by reference to his age, length of service, or prior con-
                                      tributions.
                                         Petitioners contend that the entire retirement benefit is
                                      excludable. 9 We disagree. SCD retirees were guaranteed an
                                      annual retirement allowance payable in monthly install-
                                      ments equal to 50% of their final compensation (guaranteed
                                      amount). 10 CERL sec. 31727.4. If an individual qualified for
                                      a service retirement benefit that exceeded the guaranteed
                                      amount, however, that person was eligible to receive the
                                      higher amount. Id. sec. 31727.4. Accordingly, because Mr.
                                      Sewards’ service retirement benefit (i.e., $12,861) was higher
                                      than the guaranteed amount (i.e., $7,046), his SCD retirement
                                      benefit amount was increased to his service retirement ben-
                                      efit amount, which was determined by reference to his length
                                      of service. See sec. 1.104–1(b), Income Tax Regs.; cf. Picard
                                      v. Commissioner, 165 F.3d 744 (9th Cir. 1999) (holding that
                                      reduction of taxpayer’s disability retirement benefits was
                                      determined by reference to his date of hire rather than by his
                                      age or length of service), rev’g T.C. Memo. 1997–320. Thus,
                                      the portion exceeding the guaranteed amount is not exclud-
                                      able from income.
                                         Respondent further determined that petitioners are liable
                                      for a section 6662(a) accuracy-related penalty relating to
                                      2006. Section 6662(a) and (b)(2) imposes a 20% penalty on
                                      the amount of any underpayment of tax attributable to a
                                      substantial understatement of income tax. An understate-
                                         8 Respondent does not challenge that the statute was in the nature of a workmen’s compensa-

                                      tion act.
                                         9 Pursuant to sec. 7491(a), petitioners have the burden of proof unless they introduce credible

                                      evidence relating to the issue that would shift the burden to respondent. See Rule 142(a). Our
                                      conclusions, however, are based on a preponderance of the evidence, and thus the allocation of
                                      the burden of proof is immaterial. See Martin Ice Cream Co. v. Commissioner, 110 T.C. 189,
                                      210 n.16 (1998).
                                         10 At the time of Mr. Sewards’ retirement, the guaranteed amount was $7,046. In subsequent

                                      years, this amount was increased to account for cost of living adjustments.

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                                      324                 138 UNITED STATES TAX COURT REPORTS                                     (320)

                                      ment is substantial if it exceeds the greater of $5,000 or 10%
                                      of the tax required to be shown on the return. Sec.
                                      6662(d)(1)(A). Although petitioners substantially understated
                                      their income tax, section 6664(c)(1) provides that no penalty
                                      shall be imposed if there was reasonable cause for the under-
                                      payment and the taxpayer acted in good faith.
                                        LACERA sent Mr. Sewards 2001, 2002, 2003, 2004, and
                                      2005 Forms 1099–R which did not indicate a taxable amount.
                                      LACERA, in late 2006, sent a letter to him indicating it would
                                      begin reporting as taxable a portion of his SCD retirement
                                      benefits and, in 2007, sent him a Form 1099–R reflecting the
                                      taxable portion. Over the course of several years, the guid-
                                      ance provided by LACERA varied. Petitioners, in good faith,
                                      took reasonable efforts to assess their proper tax liability.
                                      Thus, petitioners had reasonable cause for the underpayment
                                      and are not liable for a section 6662(a) accuracy-related pen-
                                      alty.
                                        Contentions we have not addressed are irrelevant, moot, or
                                      meritless.
                                        To reflect the foregoing,
                                                                          Decision will be entered under Rule 155.

                                                                               f

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