Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 62-14

1962-1 C.B. 11

Caution: Revoked by Rev. Rul. 78-161

IRS Headnote

Where a taxpayer is awarded disability compensation by the Veterans' Administration, no portion of the regular Army retirement pay based on years of service previously received by him is excludable from his gross income merely because the effective date of the award is made retroactive.

Further, if the taxpayer voluntarily refunds a portion of his previously received retirement pay to the Army in order to receive an equal amount of disability compensation from the Veterans' Administration, section 1341 of the Internal Revenue Code of 1954, relating to restoration of amounts received under a claim of right, will not be applicable in computing his income tax liability for the taxable year in which the repayment is made. Neither will the voluntary return to the Army of previously received retirement pay give rise to a deduction under section 165 of the Code.

Full Text

Rev. Rul. 62-14

Advice has been requested regarding the Federal income tax consequences of a retroactive disability compensation award by the Veterans' Administration, under the circumstances described below, with respect to regular Army retirement pay previously received.

A taxpayer was retired from the United States Army some time prior to 1958 on the basis of length of service and his retirement pay was computed on that basis. On September 29, 1958, the taxpayer filed a claim with the Veterans' Administration for compensation based on physical disability. On August 10, 1960, the Veterans' Administration determined that the taxpayer was entitled to disability compensation and authorized the payment thereof. Under the Veterans' Administration regulations, the determination was effective on September 29, 1958, the date the taxpayer's claim was filed.

Shortly after receiving notice of the disability compensation award, the taxpayer filed a waiver, pursuant to section 1005 of the Veterans' Benefits Act of 1957, 38 U.S.C. 3105, for reduction of his retirement pay in an amount equal to the disability compensation award. Effective on the date of the waiver, the taxpayer received the disability compensation from the Veterans' Administration and reduced retirement pay from the Army.

The specific issues presented in this case are (1) whether the taxpayer may, by reason of the retroactive disability compensation determination by the Veterans' Administration, exclude from gross income any portion of his regular Army retirement pay previously received, or (2) if the taxpayer refunds an amount of previously received retirement pay to the Army and receives an equal amount of disability compensation from the Veterans' Administration for such prior period, whether section 1341 or 165 of the Internal Revenue Code of 1954 will be applicable in computing his income tax liability for the taxable year in which the repayment is made.

Section 61(a) of the Code provides the general rule that gross income includes all income from whatever source derived.

Section 1.61-2 of the Income Tax Regulations provides, in part, that pay of persons in the military or naval forces of the United States, retired pay of employees, pensions and retirement allowances are income to the recipients unless excluded by law. See also section 1.61-11 of the regulations.

Section 1001(a) of the Veterans' Benefits Act of 1957, 38 U.S.C. 3101(a), provides, in part, "Payments of benefits due or to become due under any law administered by the Veterans' Administration * * * made to, or on account of, a beneficiary shall be exempt from taxation, * * *."

Section 104(a)(4) of the Code provides, in part, that gross income does not include amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the Armed Forces of any country. Section 104(a)(4) of the Code does not apply to retirement pay not constituting amounts paid on account of personal injuries and sickness.

Between the effective date of the disability compensation award and the effective date of the waiver of retirement pay in this case, the taxpayer was entitled by statute to a specific amount of retirement pay based on length of service, which he received in full as such, with every claim of right and without any restrictions. No benefits due under any law administered by the Veterans' Administration were paid to the taxpayer during this period. Nor was there any obligation on the part of the taxpayer at any time to execute a waiver of any portion of his retired pay. Further, the taxpayer was not retired from the Armed Forces for a physical disability, nor was there any question that he could have or should have been so retired. Thus, the taxpayer did not receive any amounts during the period in question as a pension, annuity, or similar allowance for personal injuries or sickness incurred in active service in the Armed Forces within the meaning of section 104(a)(4) of the Code.

Accordingly, it is held that no portion of the amount already received as retirement pay is excludable from the taxpayer's gross income and no adjustment in his tax may be made for the taxable years involved on account of the retroactive disability compensation determination by the Veterans' Administration.

Section 1341(a) of the Code provides rules for computing the tax for a taxable year if an item was included in a taxpayer's gross income for a prior taxable year or years because it appeared that the taxpayer had an unrestricted right to such item, and if a deduction in excess of $3,000 is allowable for the taxable year because it was established, after the close of such taxable year or years, that the taxpayer did not have an unrestricted right to such item or to a portion thereof.

Section 1.1341-1(a)(2) of the regulations provides, "For the purpose of this section 'income included under a claim of right' means an item included in gross income because it appeared from all the facts available in the year of inclusion that the taxpayer had an unrestricted right to such item, and 'restoration to another' means a restoration resulting because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item (or portion thereof)."

Section 1341 of the Code is intended to apply where the taxpayer has included an item in gross income because it appeared at that time that he had an unrestricted right to such item but it later developed that he did not actually have such a right. See Rev. Rul. 58-226, C.B. 1958-1, 318. Further, section 1341 applies only where it is determined in a subsequent taxable year that the taxpayer does not have an unrestricted right to the income reported and he is compelled or required to refund or repay such item. See Stewart H. Holbrook, et ux v. Commissioner, 194 Fed. Supp. 252 (1961). Thus, the restoration of the item included in the taxpayer's gross income for the prior taxable year must be involuntary on the part of the taxpayer. See  Rev. Rul. 58-546, C.B. 1958-2, 415.

Since the taxpayer in the instant case is not obliged or required to repay any amount of his retired pay to the Army, any such repayment would be voluntary.

Accordingly, it is further held that a repayment of retirement pay by the taxpayer in the instant case will not constitute a transaction meeting the requirements of section 1341 of the Code. Accordingly, the provisions of that section will not be applicable in the computation of his income tax liability for the taxable year in which the repayment is made. Neither will a voluntary return of the previously received retirement pay to the Army give rise to any deduction allowable to the taxpayer under section 165 of the Code, relating to losses.