Accrued Vacation and Sick Leave Payment Upon Retirement Not Excludable as Worker's Comp.

(Parker Tax Publishing April 29, 2015)

The Tax Court held that, although a former LAPD detective had accrued sick and vacation time while on temporary disability leave, the lump sum payment of that accrued time upon his retirement was not a payment pursuant to a worker's compensation statute and therefore could not be excluded from his income. Speer v. Comm'r, 144 T.C. No. 14.

Background

In 2009, Clarence Speer retired from his job as a detective with the Los Angeles Police Department (LAPD). During his decades-long service to the LAPD, Speer was granted several periods of temporary disability leave on account of duty-related injuries or sickness, during which he continued to accrue vacation and sick leave.

On his retirement, Speer was paid a total of $53,513 for his hours of unused vacation time and sick leave. His entitlement to this pay and benefits was governed by Memorandum of Understanding No. 24, a collective bargaining agreement between the City of Los Angeles (the City) and the Los Angeles Police Protective League. The leave payments were included in the amount of wages reported by the LAPD to Speer on his 2009 Form W-2.

Speer did not include these leave payments in the income he reported on his 2009 return. In an attachment to the Form 1040, Speer explained that he was excluding the leave payments on the ground that they had been received under a worker's compensation act. He initially identified Cal. Lab. Code sec. 4850 as the worker's compensation act, but later conceded that Section 4.177 of the Los Angeles Administrative Code (LAAC 4.177) was more applicable.

The IRS determined deficiencies in Speer's 2009 return, claiming he was not entitled to exclude the leave payments as worker's compensation.

Analysis

Code Sec. 104(a)(1) provides that amounts received under worker's compensation acts as compensation for personal injuries or sickness are excluded from gross income. Reg. Sec. 1.104-1(b) provides that the exclusion includes amounts received under a statute in the nature of a worker's compensation act.

Speer argued that, to the extent his leave payments could be allocated to vacation and sick leave benefits earned while he was on temporary disability leave pursuant to LAAC 4.177, those portions of the leave payments were excludable from his 2009 gross income under Code Sec. 104(a)(1) as amounts received under a worker's compensation act on account of personal injuries or sickness.

The IRS conceded that LAAC 4.177 was a statute in the nature of a worker's compensation act, but disagreed with Speer's characterization of the lump sum payment, arguing that Speer received the accumulated leave payments not pursuant to LAAC 4.177, but pursuant to Memorandum of Understanding No. 24, which was not a worker's compensation act.

The Tax Court observed that during each of his disability leaves of absence, Speer received periodic payments of his base salary and he accrued fringe benefits, such as vacation time and sick leave, which would translate into additional payments to him only after his disability leave of absence ended. In addition, the court noted that if, as Speer did, an employee were to forgo the vacation time and sick leave that accrued during his leaves of absence, it might be decades before the employee retired and cashed out the benefits. The court pointed out that Speer's accrual while on temporary disability leave was fundamentally different from normal temporary disability payments under worker's compensation statutes, as it did not provide him with an immediate benefit that he could use to support himself while on such leave.

The court also noted that the Workers' Compensation Act does not provide for any payments after the period of disability ends and, in fact, instructs that payments must stop or be amended upon a finding that the disability has terminated or been diminished. Thus, the court reasoned that any payments Speer received after his temporary disability ended could not be part of the City's substitute for the Workers' Compensation Act under LAAC 4.177.

The Tax Court concluded that the leave payments that were paid on his retirement, well after his disability had ended, were not paid pursuant to a statute in the nature of a worker's compensation act and were thus not excludable from Speer's gross income under to Code Sec. 104(a)(1).

For a discussion of the exclusion of amounts received under a worker's compensation act, see Parker Tax ¶75,905. (Staff Editor Parker Tax Publishing)

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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