Sewards v. Commissioner of Internal Revenue , 785 F.3d 1331 ( 2015 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
JAY AND FRANCES SEWARDS, No. 12-72985
Petitioners-Appellants,
T.C. No.
v. 24080-08
COMMISSIONER OF INTERNAL
REVENUE, OPINION
Respondent-Appellee.
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.
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 Respondent-
Appellee.
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
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.
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
involuntary medical 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
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 one-
half 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
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 a workmen’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
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 service-
connected 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 service-
connected 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,
8 SEWARDS V. CIR
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 only when 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:
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.
10 SEWARDS V. CIR
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 Treasury regulation 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.
SEWARDS V. CIR 11
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 disability payments,
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.
12 SEWARDS V. CIR
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.