Rev. Rul. 80-9

1980-1 C.B. 11, 1980-2 I.R.B. 5.

                       Internal Revenue Service
                                 Revenue Ruling

    ARMED FORCES READJUSTMENT PAYMENT; RETROACTIVE DISABILITY DETERMINATION

                          Published: January 14, 1980

26 CFR 1.61-2: Compensation for services, including fees, commissions, and similar items.

(Also Sections 104, 165; 1.104-1, 1.165-1.)

  Armed Forces readjustment payment; retroactive disability determination. A taxpayer received a lump-sum readjustment payment under 10 U.S.C. section 687(a). Later the Veterans' Administration awarded the taxpayer retroactive disability compensation, which will be withheld until the Veterans' Adminstration has recouped 75 percent of the readjustment payment. The taxpayer may not exclude any portion of the readjustment payment from gross income under section 104(a)(4) of the Code and may not deduct any portion of the amount recouped by the Veterans' Administration as a loss under section 165. Rev. Rul. 78-161 distinguished.

ISSUES

  1. May a taxpayer by reason of a retroactive disability compensation determination by the Veterans' Administration, exclude from gross income in 1976, under section 104(a)(4) of the Internal Revenue Code, any part of a lump- sum readjustment payment?

  2. Are any deductions allowable under section 165 of the Code in computing the taxpayer's income tax liability for the taxable years in which the Veterans' Administration deducts amounts from the disability compensation?

FACTS

  A taxpayer who served as a reserve officer on active duty with the United States Army for eight years was involuntarily released on January 2, 1976, and received a lump-sum readjustment payment based on years of service.  On January 3, 1976, the taxpayer filed a claim with the Veterans' Administration for disability compensation.  On December 12, 1976, the taxpayer was awarded compensation based on 20 percent disability retroactive to January 3, 1976. However, pursuant to law and an agreement with the Veterans' Administration, the taxpayer will not receive the disability payments until the Veterans' Administration has recouped 75 percent of the readjustment payment.

LAW AND ANALYSIS

  Section 687(a) of title 10 U.S.C. provides for a lump-sum readjustment payment based on years of service where a reserve member is involuntarily released from active service provided such member has completed at least five years continuous active duty prior to release.

  Section 687(b)(6) of title 10 U.S.C. provides that section 687(a) does not apply to a member who, upon release from active duty, is immediately eligible for disability compensation under a law administered by the Veterans' Administration and who elects to receive that compensation.  However, a member covered by section 687(b)(6) may receive a readjustment payment under this section and disability compensation if an amount equal to 75 percent of the readjustment payment is deducted from the disability compensation. In addition, a member who elects to receive a readjustment payment under this section is not prevented from becoming entitled to disability compensation after making that election.

  Section 3010(a) of title 38 U.S.C. provides, in part, that payments due or to become due under any law administered by the Veterans' Administration shall be exempt from taxation.

  With respect to 10 U.S.C. section 687(b)(6), in S. Rep. No. 1096, 87th Cong., 1st Sess. 4 (1961), the Senate Finance Committee states, in part:

    Under existing law a reserve is required to choose between readjustment pay and disability compensation from the Veterans' Administration.  This election has been held to be irrevocable so that a person who has received readjustment pay cannot receive compensation from the Veterans' Administration to which he may subsequently become entitled.  Since at the time of their release from active duty some persons have latent disabilities without realizing that these disabilities will later be found to be service connected, this irrevocable election has created hardships.  The proposed solution is to permit receipt of the VA compensation after deduction of three-fourths of the readjustment pay previously received.  The fractional recovery is proposed in order to take

into account the tax paid on the original payment and to avoid recoupment of an amount in excess of the net received as readjustment pay. Section 3 of this bill prevents retroactive payments of compensation from the Veterans' Administration but permits prospective receipt of this compensation subject to the deduction of three- fourths of the readjustment pay previously received.

  Section 61(a) of the Code provides that unless otherwise excluded by law, gross income means all income from whatever source derived, including compensation for services.

  Rev. Rul. 67-350, 1967-2 C.B. 58, holds that the readjustment pay received by a member of the armed forces who is involuntarily released from active duty is includible in gross income in the taxable year received.

  Section 104(a)(4) of the Code and the regulations thereunder provide, with certain exceptions not pertinent to this case, 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(b)(2)(B) of the Code provides, for tax years beginning after December 31, 1975, that section 104(a)(4) shall continue to apply to an individual who, on September 24, 1975, was a member of any organization referred to in section 104(a)(4) or under a binding commitment to become such a member.

  Section 104(b)(4) of the Code, effective for tax years beginning after December 31, 1975, provides that in the case of any individual described in section 104(b)(2), the amount excludable under section 104(a)(4) for any period with respect to any individual shall not be less than the maximum amount which such individual, on application therefor, would be entitled to receive as disability compensation from the Veterans' Administration.

  Section 165(a) of the Code allows a deduction for any loss sustained during the taxable year which is not compensated for by insurance or otherwise.

  With respect to individuals, section 165(c) of the Code limits the deduction under section 165(a) to losses incurred in a trade or business, losses incurred in transactions entered into for profit, and casualty losses.

  The United States Tax Court has consistently held that a taxpayer may not take a loss with respect to an income item, as distinguished from a capital item, unless the income has been actually received and previously reported on a tax return.  See e.g. Alsop v. Commissioner, 34 T.C. 606 (1960), aff'd, 290 F.2d 726 (2d Cir. 1961); and O'Meara v. Commission, 8 T.C. 622 (1947).

  Rev. Rul. 78-161, 1978-1 C.B. 31, announced that the Internal Revenue Service will follow the decision of the United States Court of Appeals for the Fourth Circuit in Strickland v. Commissioner, 540 F.2d 1196 (4th Cir. 1976), as precedent in the disposition of similar cases involving section 104(a)(4) of the Code.

  In Strickland, the court held that the Veterans' Administration's retroactive determination that the taxpayer was eligible for disability benefits was controlling.  Thus, the taxpayer was entitled to excluded from gross income, under section 104(a)(4) of the Code, part of the payments previously received as retirement pay based on the rank and length of service.

  This case is distinguishable from Strickland because the readjustment pay was not intended by the military and the taxpayer to be one of a series of periodic payments.  Section 104(a)(4) of the Code does not exclude amounts if they are not received as a pension, annuity, or similar allowance; and an amount is not received for the purposes of section 104(a)(4), as a pension, annuity, or similar allowance if it was not intended by its payor to be one of a series of periodic payments.

  This case is also distinguishable from Strickland because with respect to readjustment pay, the legislative history of 10 U.S.C. section 687(b)(6) indicates that Congress intended that a retroactive award of Veterans' Administration disability compensation would not allow a taxpayer to obtain a double tax benefit by excluding from gross income any readjustment pay received from the military.  See S. Rep. No. 1096.  There is no such language in the case of retirement pay.

  Finally, section 104(b)(4) of the Code does not apply to this case because the reference in that section to amounts that are excludable for any period does not include an amount that is not intended by the payor and recipient to be one of a series of periodic payments.

  The taxpayer is considered as never having received the withheld disability compensation.  This position is consistent with Rev. Rul. 67-350, 1967-2 C.B. 58, which deals with a reduction in military retirement pay to offset a previously received lump-sum readjustment payment, under a law similar to 10 U.S.C. 687(b)(6).  It was there held that there was no constructive receipt of the withheld retirement pay.  Because the disability compensation is not received by the taxpayer, the taxpayer cannot take a loss deduction as a result of the withholding of any disability compensation.

  Furthermore, even if the withheld disability compensation were regarded as the taxpayer's repayment pro tanto of the severance pay previously received and subjected to tax, a loss may nevertheless not be allowed.

  S. Rep. No. 1096 indicates that Congress intended that taxpayers would not be able to take any deductions as a result of the recoupment of readjustment pay. Congress limited the recoupment to 75 percent of the readjustment pay so as to avoid recoupment of an amount in excess of the net amount after tax received by a taxpayer, assuming an average tax bracket of 25 percent.  Such a limitation would not have been necessary if the recoupment were to give rise to a loss deduction.

HOLDINGS

ISSUE 1

  The taxpayer may not exclude from gross income under section 104(a)(4) of the Code, as a result of the Veterans' Administration award, any portion of the readjustment pay that was received from the military.

ISSUE 2

  Because the taxpayer has suffered no deductible loss as a result of the Veterans' Administration recoupment provision, the taxpayer is not allowed any deduction under section 165 of the Code.

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 78-161 is distinguished.

Rev. Rul. 80-9, 1980-1 C.B. 11, 1980-2 I.R.B. 5.