Taxing Lessons From Court Decisions

Decisions — Fireproofing the pension

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Are a firefighter’s benefits a taxable pension or workers compensation?

Generally, amounts received under workmen’s compensation acts aren’t included in income (internal revenue code section 104(a)(1)). However, under income tax regulation 1.104-1(b), the exclusion does not apply to retirement plan benefits you receive based on age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.

In T.C. Memo. 2017-132 (Taylor), the taxpayer, a firefighter, retired on disability effective June 1, 1991, in his 24th year of service, when he was 46. On that date, he began receiving a disability retirement allowance from the local governmental employees’ retirement system.

In 2012, the taxpayer received $35,153 in retirement benefits and was issued a Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Box 7 of Form 1099-R was marked with the distribution code “7” indicating a normal distribution.

The taxpayer reported $2,324 of taxable retirement income on his 2012 federal income tax return.

The IRS adjusted the taxable portion to agree with the issued Form 1099-R.

The taxpayer says the payments are not taxable because they’re compensation for personal injuries incurred in the course of his employment. He says the payments don’t constitute a pension because state law (North Carolina) defines both “annuity” and “pension” as “payments for life,” and if he were determined to be fit for work, his disability retirement payments would cease.

The IRS says the taxpayer’s disability retirement allowance was calculated with reference to his age and length of service and is includible in his gross income.


Here’s the relevant federal tax law and state statute:

From income tax regulation 1.104-1(b): Excludes amounts received under workmen’s compensation acts as compensation for personal injuries or sickness. The exclusion also applies to statutes in the nature of workmen’s compensation acts which provide compensation to employees for personal injuries or sickness incurred in the course of employment.

However, the exclusion “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.”


From North Carolina general statute section 128, article 3: Establishes and governs the retirement system for the state’s counties, cities, and towns. The local governmental employees’ retirement system is a defined benefit plan funded by employer and employee contributions.  “Creditable service” is defined as “the total of ‘prior service’ plus ‘membership service’ plus service, both noncontributory and purchased, for which credit is allowable as provided.

Under the plan, an employee with at least five years of service may retire on a disability retirement allowance upon medical certification of incapacity for the further performance of his duties. The five-year service minimum does not apply to law enforcement officers, firemen, and eligible rescue squad workers who become “incapacitated for duty as the natural and proximate result of injuries incurred while in the actual performance” of their duties.

A beneficiary’s payments are reduced if he is determined to be engaged in or be able to engage in a gainful occupation paying more than a certain amount.

An employee retiring for disability after July 1, 1982, “shall receive a service retirement allowance if he has qualified for an unreduced service retirement allowance.”

Otherwise, the allowance equals “a service retirement allowance calculated on the member’s average final compensation prior to his disability retirement and the creditable service he would have had had he continued in service until the earliest date on which he would have qualified for an unreduced service retirement allowance.”



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Right answer!

For the IRS.

The taxpayer ports the definitions of “annuity” and “pension” from the general statutes of North Carolina to interpret the phrase “retirement pension or annuity” in the regulation. However, the proper place to seek the definition of these words as used in the code and its appurtenant regulations is income tax regulation 1.104-1, which does not define “pension.”

However, within the code’s structure, subchapter D of chapter 1 of subtitle A, encompassing sections 401 through 436, governs pension plans. Section 401(a) establishes what constitutes a “qualified” pension plan, while income tax regulation 1.401-1(b)(1)(i) elaborates on the definition of “pension plan”:

A pension plan within the meaning of section 401(a) is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement.

Retirement benefits generally are measured by, and based on, such factors as years of service and compensation received by the employees. The determination of the amount of retirement benefits and the contributions to provide such benefits are not dependent upon profits. * * * A pension plan may provide for the payment of a pension due to disability and may also provide for the payment of incidental death benefits through insurance or otherwise. * * *

There is nothing to support the taxpayer’s assertion that a pension need be for life.

The taxpayer received payments from a governmental plan established by the state of North Carolina to provide definitely determinable, periodic retirement payments to former employees.

Accordingly, payments from the plan are payments from a “retirement pension or annuity” as those words are used in income tax regulation 1.104-1(b).

The taxpayer’s income is a retirement pension determined by reference to his age or length of service, or his prior contributions, and under the code cannot be excluded from his gross income for the 2012 tax year.