Jeremiah Francis O'Neill, Petitioner

T .C . Summary Opinio n 2009-13 1

UNITED STATES TAX

COUR T

JEREMIAH FRANCIS O'NEILL, petitioner v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 6708-08S .

Filed August 25, 2009 .

Jeremiah Francis O'Neill, pro se .

Joan M . Casali , for respondent .

ARMEN, Special Trial Judge : This Lase was heard pursuant to the provisions of section 7463 of the I~'ternal Revenue Code i n effect when the petition was filed .' Pu rsuant to sectio n 7463(b), the decision to be entered is rot reviewable by an y ' Unless otherwise indicated, all 'subsequent section references are to the Internal Revenue Code in effect for th e taxable years in issue .

SERVED AUG 2 5 2009

2 - 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 i n ( income,;taxes of $5,894, $6,146, and $6,313, res ective l { P Y . and (2 ) a'ecuracy-related penalties under section 6662(a) for substantia l understatement of income tax of $1 179 , , , $1 229 , and $1 26 3 , , a,_respectively . The issues for decision are : (1) Whethe r petitioner ma exclude from { g ross income p y a ments received fro m ~ ..'the.,New York City Fire Department Pension Fund ; and (2) whethe r npet 1onn r(is liable for the accuracy -related penalty under .section 6662 ( a) for each of the years at issue .

. We hold tha t 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 s o 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 remaining 19 years . At-the time petitic ner transferred to the fire department, the New York City Fire Department, Article 1-B Pension Fund (Pension Fund) assumed-liab ility for any retiremen t earnings he had accumulated as a police officer .

See N .Y . Cit y Admin . Code secs . 13-301 through 13-379 .

1 (2009) . The Pensio n Fund required members to contribute a sp ecified amount throug h payroll deductions determined by the memp er's age at appointment .

.Upon the member's 20th anniversary these mandatory contribution s ceased . During the course of his employ ent with the City of New York, petitioner contributed'$5,894 .46 t the Pension Fund .

In addition to the mandatory member contributions,, the City of New York contributed a small amount o behalf of each member as well as an additional larger amount 't maintain the overal l integrity of the Pension Fund . The Pens~o n Fund did not maintai n separate member accounts and 'did not distinguish between employer and employee contributions with respect o the categories o f .

retirement . Instead, the Pension Fund p oled all of the contributions into a contingency reserve fund .

The Pension Fund provided three categories of retirement :

Regular service, ordinary disability, an 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 V 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 performanc e 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 membe r received .

Petitioner received ordinary disability retirement from th e 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 that petitioner be granted ordinary disa bility retirement . As a result, on May 28, 1976, the Board of Tr ustees of the Pension Fund directed the retirement of petition er for a "Non-Service Incurred Disability" with a retirement d ate 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 st ill is) petitioner's position that these payments were tax-fr ee pension insurance payments received as a result of his pr e ium payments o f $5,894 .46 made during his tenure with th City of New York-.

A .

Includability of'Pension Fund Pa men s Discussion 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 po er .'" 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) (cid:127) .

Statutory exclusions from income are matters of legislative grace and are narrowly construed . Co mm issioner v . Schleier, 51 5 U .S . 323, 328 (1995) . Taxpayers seeking) an exclusion from income 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 o n 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 . '

(continued .

.

.

f Under this provision ,- if the taxpayer would recover his total contribution in the first 3 years of hi 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 b includable in gros s income .

I'd .

Petitioner retired in 1976, and alt hough it is unclear wha t amount, if any, he received in 1976, he received disabilit y retirement benefits in 1977-of $17,303 .0 4 . Because the amount received in 1977 exceeded petitioner's t otal contributions of $5,894 .46 and was within the 3-year peri od, he was eligible t o exclude his contributions toithe Pension Fund from his taxable income for taxable year 1977 . All subse uent payments were to b e included in petitioner's gross income .

B . Exclusion Provisions of Sections 104 and 10 5 Section 72 applies to "a pension plan * * * which provides for the payment of pensions at retiremen and the payment of an earlier pension in the event of permanen disability ." Sec .

1 .72-15(a), Income Tax Regs . However, s ction 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 10 4 z( .

. .continued) 2467, 2470, as amended by the Technical Act of 1988, Pub . L . 100-647, sec . 1011A Stat . 3472, 3474 .

nd Miscellaneous Revenue b) (2) (A), (12)-(15), 102 8 - and 105 . Sec . 1 .72-15(b), Income Tax Begs . 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 reason s ' Par . (5) of sec . 104(a), which applies to victims of terrorist attacks, is on its face inapplicable to the facts before us .

9 - other than service-incurred injuries . aar 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 injuri s . The resolution adopted by the Board of Trustees of the ension Fund on May 28, 1976, awarded retirement benefits to pettioner on account of a non-service-incurred disability . These benefits are, therefore, not excludable from gross income under s ction 104(a)(1) .

Section 104(a)(2) excludes from gro s'income damages "received (whether by suit or agreement * *) on account o f personal physical injuries ortphysical s ckness" . "The term 'damages-received (whether by suit or agreement)' means an amoun t received * * * through prosecution of a egal suit or action based upon tort or tort type rights, or hrough a settlement agreement entered into in lieu of such'p osecution ." Sec . 1 .104- 1(c), Income Tax Regs . Thus,`"-The essen ial element of a n exclusion under 104(a)(2) is that the in oP e .inbolved must derive from some sort of tort claim against the payor ." ' Glynn 'v .

Commissioner , 76 T .C . 116, 119 (1981), a fd . without published opinion 676 F .2d 682 (1st Cir . .1982) .

10 - 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 ."

Baanell v . Commissioner , T .C . Memo . 1993-378 (citing Chosiad v . Commissioner , T .C . Memo . 1980-408) . Moreover, unless the plan expressly provides otherwise, the .law presumes a contributing plan .that provides both .dis ability and retiremen t benefits sources the disability benefit s in employe r contributions.

The Pension . Fund required petitione r to contribute, provided both disability and retirement benefits , and, contained no expres s provision : on the source of_ the, disabili t y benefits . Therefore,' the benefits,received ;by petitioner are not excludable unde r section 104(a)(3) .

Section .105 is the . mirror . image to section 104(a .) .-(3) buts provides two exceptions to iricludabilit . .-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 o :the extent such amounts (1 ) constitute "payment for the permanent loss or loss of use of a member or- .function of-the body, or th permanent disfigurement, of the taxpayer, *" * * .: and (2) are : comp ted . with reference to the nature of the .injury, without . regard to he .period .the employee i s absent from work ." Courts have interpr ted .section 105(c) . t exclude payments from gross income only if the plan or contract under which such payments are made vari s the amount .of the i 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 13 - irrelevant, and petitioner does not sat i ~fy the requirements-o f section 104(a)(4) .

On the basis of foregoing, petition r is not entitled t o exclude from . gross income the ordinary d sability retirement benefits he received from the New York_ City Fire Department, Article 1-B Pension Fund . Accordingly, e hold that the ordinar y disability retirement benefits petitions, received in 2004, 2005, and 2006 constitute gross income for eac year .

C ., Section 6662(a) Penalt y Section 6662(a) and (b)(2) imposes penalty equal to 20 percent of the amount of any underpaymen attributable to a substantial understatement of income tax . An understatement of income tax is substantial if the underst tement exceeds the greater of 10 percent of the tax require to be shown on the return or $5,000 . Sec . 6662(d)(1)(A) . he definition of understatement for this purpose is the e cess of the tax required to be shown on the return over the tax actually shown on th e 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 i applicable with respect 14 - 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 tha t 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 .

2. This provision was repealed by the Tax Reform Act of 1986, Pub . L . 99-514, sec . 1122(c)(1), (h) (l) - (7) , 100 Stat .