Woolard v. Commissioner

Leland W. Woolard, Petitioner v. Commissioner of Internal Revenue, Respondent

Woolard v. Commissioner

Docket No. 193-65

United States Tax Court

47 T.C. 274; 1966 U.S. Tax Ct. LEXIS 10;

December 8, 1966, Filed

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Decision will be entered for the respondent.

Amount received as readjustment pay by a reserve officer in the U.S. Air Force when involuntarily released from active service is includable in his taxable income in the year received even though there was a possibility that he might have to "repay" 75 percent of that amount through reduction in his retirement pay if he subsequently became eligible for such retirement pay after reenlistment and completion of 20 years of active service.

Leland W. Woolard, pro se.

Vernon J. Owens, for the respondent.

Raum, Judge.

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RAUM

The Commissioner determined a deficiency in income tax of petitioner for the year 1962 in the amount of $ 3,098.

The sole question for decision is whether petitioner is entitled to exclude from taxable income in 1962 $ 9,225 of the $ 12,300 he received from the U.S. Air Force as readjustment pay during that year.

FINDINGS OF FACT

Most of the facts have been stipulated, and, as stipulated, are incorporated herein by reference.

Petitioner, a resident of Miami, Fla., filed an individual income tax return for the year 1962 with the district director of internal revenue, Jacksonville, Fla.

In June 1962, petitioner was a commissioned officer on active duty with the U.S. Air Force in the grade of captain (reserve grade of major) and had completed approximately 16 years of active service. A special order, dated June 13, 1962, was issued by the Headquarters 4039th Strategic Wing of the Air Force releasing petitioner from active duty effective June 30, 1962. After receiving this order, petitioner, on June 26, 1962, signed a statement agreeing to accept $ 4,200 as readjustment pay under the provisions of the Armed Forces Reserve Act of 1952, as amended by the Act of July 9, 1956, Pub. L. No. 676, 84th Cong., 70 Stat. 517, 50 U.S.C. sec. 1016. Public Law No. 676 provided, in part, as follows:

the Armed Forces Reserve Act of 1952 (66 Stat. 481), as amended, is further amended by adding the following section after section 264:

"Sec. 265. (a) A member of a reserve component who is involuntarily released from active duty after the enactment of this section and after having completed immediately prior to such release at least five years of continuous active duty, except for breaks in service of not more than thirty days, as either an officer, warrant officer, or enlisted person, is entitled to a lump-sum readjustment payment computed on the basis of one-half of one month's basic pay in the grade in which he is serving at the time of release from active duty for each year of active service ending at the close of the eighteenth year. For the purposes of computing the amount of readjustment payment (1) a part of a year that is six months or more is counted as a whole year, and a part of a year that is less than six months is disregarded, and (2) any prior period for which severance pay has been received under any other provision of law shall be excluded. There shall be deducted from any lump-sum readjustment payment any mustering-out pay received under the provisions of the Mustering-Out Payments Act of 1944 or the Veterans Readjustment Assistance Act of 1952.

* * * *

"(c) The acceptance of readjustment pay under this section shall not deprive a person of any retired pay, retirement pay, retainer pay, or other retirement benefits from the United States to which he would otherwise become entitled."

The $ 4,200 which petitioner agreed to accept as readjustment pay under the provisions of Public Law No. 676 was equivalent to one-half month's base pay for each year of active duty, less World War II mustering-out pay.

Subsequent to June 26, 1962, and prior to petitioner's release from active duty on June 30, 1962, Pub. L. 87-509, 87th Cong., 76 Stat. 120, 50 U.S.C. sec. 1016, was approved on June 28, 1962. It provided, in part, as follows:

section 265 of the Armed Forces Reserve Act of 1952, as amended (50 U.S.C. 1016), is amended as follows:

(1) Subsection (a) is amended to read as follows:

"(a) A member of a reserve component who is involuntarily released from active duty after the date of enactment of this amended subsection and after having completed immediately prior to such release at least five years of continuous active duty * * * is entitled to a lump-sum readjustment payment computed on the basis of two months' basic pay in the grade in which he is serving at the time of release from active duty for each year of active service (other than in time of war or of national emergency hereafter declared by Congress) ending at the close of the eighteenth year. * * * No person covered by this subsection may be paid a total of more than two years' basic pay in the grade in which he is serving at the time of release or $ 15,000, whichever is the lesser. There shall be deducted from any lump-sum readjustment payment under this subsection any mustering-out pay received under the Mustering-Out Payment Act of 1944 * * *."

* * * *

(4) Subsection (c) is amended to read as follows:

"(c) A member of a reserve component who has received a readjustment payment under this section after the date of enactment of this amended subsection and who qualifies for retired pay under any provision of title 10 or title 14, United States Code, that authorizes his retirement upon completion of 20 years of active service, may receive that pay subject to the immediate deduction from that pay of an amount equal to 75 percent of the amount of the readjustment payment, without interest."

Under the provisions of section 265 of the Armed Forces Reserve Act of 1952, as amended by Public Law 87-509, petitioner was entitled to 2 months' base pay for each year of active duty not to exceed for his grade, $ 12,600, less mustering-out pay. The net amount that he was entitled to receive under that law for readjustment pay, less withholding taxes, was $ 12,300, and in August of 1962 he received a check for this amount from the Air Force. Despite the fact that petitioner returned this check to the Air Force Finance Center in Denver, Colo., it was returned to him for acceptance since Public Law 87-509 became effective 2 days prior to the effective date of his separation orders.

When petitioner finally received and accepted the check returned to him by the Air Force, he had already reenlisted in the Air Force and had obligated himself to remain in the Air Force for the period of the enlistment which was anticipated to terminate in his retirement. Barring the possibility that he would not be allowed to retire, he could reasonably anticipate that upon retirement on May 30, 1966, he would be obligated to commence "repaying" out of his retirement pay $ 9,225 (75 percent) of the $ 12,300 received from the Air Force as readjustment pay in August 1962.

In his 1962 income tax return petitioner included as income only $ 3,075 of the readjustment pay of $ 12,300 received by him in that year. The difference between these two amounts, $ 9,225, which was not included in his income, is the amount by which his retirement pay would be reduced if and when he becomes eligible for retirement pay. The Commissioner determined that the excluded amount was taxable income received by petitioner in 1962, and in determining the deficiency added $ 9,225 to the income reported by petitioner in his return for that year.

OPINION

In 1962, petitioner became entitled to, and received, readjustment pay in the amount of $ 12,300 under the provisions of the Act of June 28, 1962, Public Law 87-509, supra, p. 276, because he was involuntarily released from active duty as a reserve officer in the U.S. Air Force on June 30, 1962, after completion of approximately 16 years of service. That law provided in part, however, that the future retirement pay of such officer who might retire after 20 years of service must be reduced by an amount equal to 75 percent of the readjustment pay, without interest. The reason for requiring such reduction in retirement pay appears in a letter from the Defense Department to the Chairman of the Senate Committee on Armed Services, which was incorporated in S. Rept. No. 1096, 87th Cong., namely, to preclude dual crediting of time for both retirement pay and readjustment pay. And the reason for limiting the reduction in the retirement pay to only 75 percent of the readjustment pay also appears in the same Senate committee report, namely, that the remaining 25 percent would in general be utilized to pay taxes upon the readjustment pay. In this connection the committee report stated (pp. 5, 6):

The committee recommendation is that for those persons who qualify for retired pay based on 20 years of active duty after having received readjustment payments, three-fourths of the readjustment payments must be repaid before the person begins the receipt of retired pay. The reason for not requiring full repayment is that without considering the taxes paid on the readjustment pay a Reserve would be required to repay more than the net he had received as readjustment pay. Since the tax consequences for different Reserves would vary, depending upon their other income, the committee decided that a three-fourths repayment is reasonable.

It is thus clear that the Senate committee understood that the readjustment payment would be subject to tax, and it arbitrarily selected 25 percent as an average rate that would be applicable to the servicemen covered by the statute.

Petitioner contends that the Commissioner erred in including the portion of the readjustment pay amounting to $ 9,225 which he received in 1962 in his taxable income for that year. He argues that on June 26, 1962, he applied for and agreed to accept readjustment pay of $ 4,200 under the provisions of the Act of July 9, 1956, Public Law No. 676 (set forth in our findings); that this law contained no provision for repayment of readjustment pay in the event the applicant subsequently qualified for retirement pay; that he never applied for or agreed to accept readjustment pay under the provisions of the Act of June 28, 1962, Public Law 87-509, which was in effect on June 30, 1962, when he was released from active duty; that in August 1962 he received a check from the Air Force for $ 12,300 which represented the amount of readjustment pay he was entitled to receive under Public Law 87-509; that inasmuch as he had not agreed to accept readjustment pay under that law he returned the check to the Air Force; that after he had reenlisted to complete his retirement eligibility the Air Force returned the check to him and he accepted it because he had no other choice; that under the provisions of Public Law 87-509 he became obligated to repay 75 percent of $ 12,300, or $ 9,225, from the moment it was received because he had already reenlisted to qualify for retirement; that in the circumstances he never had unrestricted use of, or full dominion over, the $ 9,225 in 1962; and that since he had only temporary use of this money and it had to be repaid in later years, it represented the proceeds of a "loan" and did not constitute taxable income for 1962.

We do not agree with petitioner. At the time he was involuntarily released from active duty in the Air Force on June 30, 1962, the Act of July 9, 1956, Public Law No. 676, had been superseded by the Act of June 28, 1962, Public Law 87-509, and the amount of readjustment pay he was entitled to receive and the amount he would have to "repay" in the event he subsequently completed the 20 years of active service which qualified him for retired pay, were governed by the provisions of Public Law 87-509. In August 1962, he received from the Air Force a check for $ 12,300 which was the amount of readjustment pay he was entitled to receive under that law. Although he returned that check to the Air Force he accepted it when it was subsequently returned to him in that year and thus became obligated to comply with the provisions of the law with respect to "repayment." There is no merit to petitioner's contention that from the moment the check was returned and accepted by him he became obligated to "repay" 75 percent of $ 12,300, or $ 9,225, because he had prior thereto reenlisted to qualify for retirement. Under the provisions of Public Law 87-509, the obligation to "repay" 75 percent of the readjustment pay received did not arise when he reenlisted to qualify for retirement. It arose if, and when, after reenlistment, he completed the 20 years of active duty which qualified him for retired pay. Inasmuch as in 1962, when he received the readjustment pay, he had to complete approximately 3 years of additional active duty before he became eligible for retired pay, no obligation to "repay" any part of that pay then existed, and in the absence of such an obligation, there is no justification for treating part of the readjustment pay received in that year as the nontaxable proceeds of a loan. In 1962 there existed merely the possibility that 75 percent of the readjustment pay might be reflected in a reduced retirement annuity, a contingency that depended at the very least upon his being alive and remaining in the the Armed Forces until the date of retirement. And upon the happening of that contingency he would then be taxed only upon the reduced annuity in the future years and not upon the gross amount thereof.

In these circumstances the proper tax treatment of these payments is to treat the readjustment pay as taxable income when received in 1962, and to tax only the reduced amounts of retirement pay in future years when and if paid to petitioner. In short, petitioner is taxable upon the amounts actually received in the years that he receives them. Whether the case be looked upon as one with a reduced retirement annuity in future years or one in which petitioner would be required to "repay" 75 percent of the readjustment pay out of that annuity, the result must be the same. For even if the latter view be taken, petitioner meanwhile had the unrestricted and uncontested right to use the entire readjustment pay for his own purposes, subject only to restoring a portion thereof out of retirement pay, if he should infact retire in a later year. The mere fact that income received by a taxpayer may have to be returned at some later time does not deprive it of its character as taxable income when received. Cf. Healy v. Commissioner, 345 U.S. 278">345 U.S. 278; North American Oil v. Burnet, 286 U.S. 417">286 U.S. 417, 419; Whitaker v. Commissioner, 259 F. 2d 379, 382-383 (C.A. 5); Phillips v. Commissioner, 238 F. 2d 473, 475-476 (C.A. 7). Here the payment represented additional compensation for service in the Air Force. See Rev. Rul. 58-496, 2 C.B. 20">1958-2 C.B. 20. It was income when received.

Decision will be entered for the respondent .