Internal Revenue Service
Revenue Ruling
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smRev. Rul. 77-28
1977-1 C.B. 27
Section 72
Section 105
IRS Headnote
Sick pay exclusion for civil service retiree; pre-1976. A Federal Civil Service employee retired before the mandatory retirement age on a regular annuity. After filing 1974 and 1975 income tax returns and excluding retirement payments as recovery of cost, the employee was certified as eligible for disability retirement. If the employee timely files Form 5401 (Agreement to Apply Sick Pay Exclusion to Retirement Annuity) electing to have the 1974 retirement payments treated in part as sick pay, the excess retirement payments over the sick pay exclusion will be a recovery of cost. The sick pay exclusion must also be claimed in an amended return for 1975 but the excess of the retirement payments for that year over the sick pay exclusion must be included in the employee's gross income.
Full Text
Rev. Rul. 77-28
Advice has been requested regarding the Federal income tax treatment of payments received during the calendar years 1974 and 1975, under a wage continuation plan by a retired civilian employee of the United States Government who retired prior to January 27, 1975.
A retired on July 1, 1974, at age 55, after 30 years of service, on a regular annuity of $12,200 per annum, even though on that date A was actually disabled. A's initial retirement age was 55 and mandatory retirement age was 70. In timely filed Federal income tax returns for the calendar years 1974 and 1975, A excluded $18,300 of the annuity payments received during such years as recoveries of the annuity cost under the 3-year rule of section 72(d) of the Internal Revenue Code of 1954. Prior to retirement A had requested to be placed on a disability status. On May 3, 1976, after A's income tax return for the calendar year 1975 had been filed, the United States Civil Service Commissioner certified A's eligibility for wage continuation benefits because of personal injuries or sickness from the date of A's retirement until A reaches mandatory retirement age. If, on July 1, 1974, A had retired on disability A would have been entitled to exclude as sick pay under section 105(d) $2,200 of the amount received during the remainder of 1974.
For taxable years prior to January 1, 1976, section 105(d) of the Code provides, in part, that gross income does not include amounts (within certain dollar limitations) that are wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injury or sickness.
Section 1.105-6(a) of the Income Tax Regulations provides, in part, that an employee who retired before January 27, 1975, on a regular annuity (although actually disabled) may, as of the date of retirement, apply the sick pay exclusion to the annuity payments until the employee reaches mandatory retirement age if the following requirements are met;
(1) The employer had in operation at the time of the employee's retirement a program providing accident and health benefits under a wage continuation plan;
(2) The employer certifies, under procedures approved in advance by the Internal Revenue Service, that the employee would have been eligible for disability retirement under the plan because of personal injuries or sickness;
(3) At the time of the employee's retirement there was no substantive difference between the benefits actually received and the benefits the employee would have received had the employee retired under the employer's wage continuation plan; and
(4) The employee agrees to the adjustments and conditions required by the Commissioner with respect to amounts excluded under section 72(b) or (d) of the Code in taxable years ending before January 27, 1975.
The certification required in paragraph (a)(2) and the agreement required in (a)(4) of section 1.105-6 of the regulation are to be filed on or before April 15, 1977, with the return, or in a timely filed amended return or claim, made for the taxable year in which the employee reached retirement age (initial retirement age), or for the first taxable year for which the taxpayer files an income tax return claiming an exclusion under section 105(d) of the Code. Form 5401, Agreement to Apply Sick Pay Exclusion (Section 105(d)) to Retirement Annuity, may be used for this purpose.
Section 1.72-15(i)(1) of the regulations provides, in part, that a taxpayer, who reaches initial retirement age before January 27, 1975, and under a pension plan established by the employer, received payments that qualify as wage-continuation benefits pursuant to section 105(d) of the Code, is entitled to an exclusion for taxable years ending before January 27, 1975, with respect to payments received after initial retirement age but before mandatory retirement age. The amount of such exclusion is the greater of the amount actually excluded under section 72(b) or (d) as a recovery of cost of the annuity or the amount that would have been excluded as sick pay.
Section 1.72-15(i)(2) of the regulation provides, in part, that a taxpayer described in paragraph (i)(1) of that section shall redetermine the cost of the annuity contract in accordance with the applicable rules of section 72 of the Code and the regulations thereunder. In making such determination the taxpayer's investment in the annuity contract is to be decreased by the excess (if any) of the annuity exclusion over the amount that could have been excluded as sick pay.
In the instant case, A reached initial retirement age, but not mandatory age, before January 27, 1975. Accordingly, A is entitled to the sick pay exclusion of $2,200 for the period July 1, 1974 through December 31, 1974. Further, since such period is within the taxable year ended before January 27, 1975, and the amount actually excluded for such period, ($6,100), exceeded the amount that could have been excluded as sick pay, ($2,200), A will be entitled to such greater exclusion, provided A timely files Form 5401, together with the required certification and the agreement to decrease the cost of the annuity by $3,900, the amount of such excess. If all of these requirements are met, A will not be required to include in gross income for the calendar year 1974 the amount of $3,900 representing the excess of the amount received over the sick pay exclusion for such year.
However, for taxable years ending on or after January 27, 1975, there are no existing provisions in the Code or the regulations thereunder that will permit a taxpayer to exclude from gross income the greater of the annuity exclusion or the sick pay exclusion.
Accordingly, in this case, if A timely files Form 5401 and the required certification and agreement, thereby electing to have retirement payments treated as sick pay, A must file an amended return for the calendar year 1975, claim the sick pay exclusion of $5,200 and report in gross income $7,000, the amount by which the retirement payments of $12,200 received in 1975 exceeds $5,200, the amount of the sick pay exclusion.
However, sections 505(a) and (d) of the Tax Reform Act of 1976, Pub. L. 94-455, 94th Cong., 2d Sess., (October 4, 1976) [1976-3 C.B. (Vol. 1) 42] made substantial changes in section 105(d) of the Code relating to the sick pay exclusion, for years beginning after December 31, 1975. Therefore, for such years, a determination as to whether a taxpayer is entitled to the sick pay exclusion and the amount thereof, if any, must be made under section 105(d) as changed by the Tax Reform Act of 1976.