Disability Benefits Paid Under Dual-Purpose Statute Were Excludable from Income

(Parker Tax Publishing April 2023)

A district court held that a taxpayer was entitled to a refund of taxes she paid on her disability retirement benefits because the benefits were excludable from income under Code Sec. 104(a)(1) and Reg. Sec. 1.104-1(b) as benefits paid pursuant to a statute in the nature of a workmen's compensation act. The court found that the statute under which the taxpayer received her benefits was a dual-purpose statute because it allowed for disability pay for both work-related and non-work-related injuries, and concluded that taxpayer's benefits were paid pursuant to language in the statute that was in the nature of a workmen's compensation act. Kiczuk v. U.S., 2023 PTC 77 (D. Conn. 2023).

Background

Diane Kiczuk was employed by the State of Connecticut for over 20 years until she retired in 2009. Kiczuk originally entered state service in 1981 as a mental health worker and remained in that role until 1983. She reentered Connecticut state service in 1986 and remained a State of Connecticut employee in different capacities until her retirement.

Kiczuk allegedly sustained multiple injuries over the time period that she was employed with the State of Connecticut. In 2008, when leaving work for the day, Kiczuk fell outside on her way to the parking lot. After this injury, Kiczuk returned to work in Spring 2009 for a 90-day period. Kiczuk applied for disability retirement due to symptoms allegedly relating to the December 2008 fall. The field of the Application entitled "Type of Retirement" listed two disability-retirement options: "Disability (Non-Service Connected)" and "Disability (Service Connected)."

Kiczuk indicated on the application that she was seeking service-connected disability retirement and marked the "Yes" box in response to the inquiry above, indicating that she would accept non-service-connected disability benefits if she was not approved for service-connected benefits. Kiczuk provided testimony as well as medical records in support of her application to the State of Connecticut Medical Examining Board (MEB), which held a hearing on Kiczuk's application in March of 2011. After listening to the testimony and reviewing all the documentation, the MEB issued a Notice of Decision approving Kiczuk's "application for service-connected disability retirement." The Notice of Decision indicates that "[t]he applicant's case was initially heard in March of 2010 and it was noted the applicant's pain symptoms were consistently noted to be out of proportion to objective findings." The Decision further states that, while Kiczuk's reported symptoms are "not clearly related to the [December 2008] fall . . . . The Board finds, on balance, that i[t] is more likely than not, based on the evidence available at this time, that the applicant's fall substantially contributed to her current symptoms."

Kiczuk thereafter began receiving disability retirement benefits from the State Employees Retirement System (SERS). Under to the "60% Minimum" SERS rule, her disability retirement benefits were allegedly calculated to be sixty percent of her rate of salary, less the amounts she received from social security.

When Kiczuk filed her federal income tax returns for the 2015, 2016, and 2017 tax years, she included her disability retirement benefits in the calculation of her taxable gross income, and therefore paid taxes on those benefits. In 2019, Kiczuk submitted amended tax returns claiming that her disability retirement benefits should be excluded from taxable gross income and therefore seeking refunds for the overpayment of taxes on those benefits. The IRS denied Kiczuk's refund request, and her subsequent attempts to appeal the IRS's decision were unsuccessful. In 2021, Kiczuk filed a refund action against the IRS in a district court.

Under Code Sec. 104(a)(1), amounts received under workmen's compensation acts as compensation for personal injuries or sickness are excluded from gross income. Reg. Sec. 1.104-1(b) interprets the statute to also exclude from gross income any amounts received by an employee 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. The regulation also states that Code Sec. 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.

In Rutter v. Comm'r, 760 F.2d 466 (2d Cir. 1985), the Second Circuit held that, in order to determine whether a statute is in the nature of a workmen's compensation act, the proper focus is on the nature of the statute, rather than the source of the injury. According to the Second Circuit, a statute that does not distinguish between work-related injuries and other types of injuries is not in the nature of a workmen's compensation statute. The Second Circuit further found that, unless a statute contains some provision restricting the payment of benefits to cases of work-related disabilities, it is not in the nature of a workmen's compensation statute.

In a motion for summary judgment, Kiczuk argued that her disability retirement benefits, which she received pursuant to Section 5-192p of the Connecticut General Statutes, were excludable from her gross income under Code Sec. 104(a)(1). Kiczuk focused on the "distinguish" language in Rutter, arguing that as long as a statute distinguishes between work-related and other types of injuries, the payments received thereunder are excludable from gross income. Kiczuk contended that Section 5-192p is a "dual-purpose" statute which allows for disability pay for both work-related and non-work-related injuries, and her benefits were excludable because they were paid under the provision of the statute that restricts payment to only work-related disabilities.

The IRS, on the other hand, focused on the Rutter court's holding that a statute must restrict the payment of benefits to cases of work-related disabilities. A statute that merely distinguishes between work-related and non-work-related disabilities, the IRS contended, is not in the nature of a workmen's compensation act. The IRS argued that the court should not recognize dual-purpose statutes as falling within the scope of Code Sec. 104(a)(1). Doing so, the IRS reasoned, would be inconsistent with Rutter because a dual-purpose statute by definition does not restrict payments to instances of work-related injuries. Moreover, the IRS asserted that analysis of dual-purpose statutes would require inquiry into the source of the injury, and thus would break with the Second Circuit's approach of looking only at the nature of the statute.

Analysis

The district court granted Kiczuk's motion for summary judgment. The court recognized that disability benefits received under a dual-purpose statute may be excludable under Code Sec. 104(a)(1). Further, the court concluded that Section 5-192p is a dual-purpose statute and that Kiczuk's benefits were paid under the provision of it that is in the nature of a workmen's compensation act.

The court saw no impediment to recognizing that payments received under a dual-purpose statute may be excludable from gross income if the taxpayer can demonstrate that they receive payments pursuant to a portion of the statute that is in the nature of a workmen's compensation act. The court explained that, once a statute is determined to be a dual-purpose statute, the focus is not on the source of the injury, as the IRS argued, but rather on whether the taxpayer in fact received her disability retirement benefits under the specific provision that is in the nature of a workmen's compensation act. The court further found that a dual purpose statute is not inconsistent with the mandate in Reg. Sec. 1.104-1(b) that Code Sec. 104(a)(1) does not apply to a retirement pension or annuity to the extent that it is determined by reference to the age or length of service, or the employee's prior contributions. The point of recognizing that a statute has dual purposes, the court explained, is that one such purpose might result in excludable income and the other might not.

Next, the court analyzed the language of Section 5-192p and found that the statute is a dual-purpose statute because it both distinguishes between work-related and non-work-related injuries and restricts payment of disability retirement only to cases of work-related disabilities. The court also found that Kiczuk met her burden of establishing that her disability retirement benefits were paid under the portion of Section 5-192p that provides benefits for work-related disabilities. In the court's view, the decision by which Kiczuk's benefits were approved made clear that the MEB found her disability to be service connected, given that the MEB determined it was "more likely than not" that Kiczuk's fall "substantially contributed" to her current symptoms. The court reasoned that if the MEB did not determine under which provision of Section 5-192p Kiczuk was receiving benefits, then it would not have needed to reach a conclusion regarding the causal relationship between her injury at work and her claimed disability.

For a discussion of the exclusion from income for amounts received under workmen's compensation acts, see Parker Tax ¶75,905.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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