Campbell v. U.S., et al (CA 6/5/2015) 115 AFTR 2d ¶ 2015-807
In consolidated cases, the Court of Appeal for the Ninth Circuit, affirming the lower courts, has concluded that firefighters, who retired with service-connected disabilities, couldn’t exclude from income under Code Sec. 104(a)(1) (as amounts received under workmen’s compensation acts for personal injuries or sickness) the amount by which their retirement benefits exceeded the amounts that they were entitled to receive on account of their disability.
Background. Under Code Sec. 104(a)(1), retirement payments are excludable from gross income if they are “received under workmen’s compensation acts as compensation for personal injuries or sickness.” However, Code Sec. 104(a)(1) doesn’t apply to the extent the payments are determined by reference to the employee’s age or length of service or his prior contributions, even if his retirement is occasioned by occupational injury. (Reg. § 1.104-1(b))
The rule of Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., (S Ct 1984), 467 U.S. 837, also referred to as Chevron deference, is a tool of statutory construction whereby courts are instructed to defer to the reasonable interpretations of executive branch agencies charged by Congress to fill any gap left, implicitly or explicitly, in the statutes they administer. Chevron deference requires a court to undertake a 2-part analysis to review an agency’s reg. At the first step, a court must look to the “plain meaning” of the statute and determine if the reg responds to it. If it does, the inquiry need not continue. At the second step, if the statute is silent or ambiguous, a court must determine whether a given reg is a permissible construction.
Facts. At the time in issue, Los Angeles County employees who retired with a service-connected disability were entitled to receive a pension equal to half the employee’s final salary. If the employee qualified for a service pension in an amount greater than half the employee’s final salary, the employee received the service pension amount.
The taxpayers in the consolidated appeals were retired Los Angeles County firefighters who had service-connected disabilities. Each of the taxpayers received a pension equal to the amount of their service pension, which was calculated based on years of service. They each filed a separate action in the district court seeking a tax refund, and the district court granted summary judgment to the government in each of the cases. The taxpayers appealed the district court decisions.
Court’s conclusion. The Ninth Circuit concluded that the portion of each of the taxpayers’ pensions that exceeded half his final salary was determined by reference to his length of service, and, accordingly, was not excludable under Reg. § 1.104-1(b).
The Court rejected the taxpayers’ contention that Reg. § 1.104-1(b) was invalid because IRS lacked the authority to issue it. The Ninth Circuit noted that, under Code Sec. 7805(a), the Treasury Department has the authority to issue “all needful rules and regulations for the enforcement of [the Internal Revenue Code].” The Court found that Reg. § 1.104-1(b) satisfied the Chevron analysis and was a valid reg: Code Sec. 104(a)(1) did not directly address the precise question at issue, and the regs were a reasonable interpretation of Code Sec. 104(a)(1).
The Ninth Circuit also rejected the taxpayers’ argument that Supreme Court precedent prohibited applying Chevron deference in this case. IRS had not interpreted Code Sec. 104(a)(1) in an inconsistent manner, nor had the Supreme Court interpreted the statute in a way that conflicted with Reg. § 1.104-1(b).
Prior treatment by IRS. In addition, in the case of two of the taxpayers, the Court found that IRS wasn’t bound to treat the entirety of their pensions as excludable simply because it had done so previously. Because there were no court decisions addressing whether the taxpayers’ pensions were taxable, the “law of the case doctrine” wasn’t applicable. Under that doctrine, a court is ordinarily precluded from reexamining an issue previously decided by the same court, or a higher court, in the same case; but to constitute law of the case, an issue must have been previously decided either explicitly or by necessary implication in the previous disposition.
The Court also found that the doctrine of equitable estoppel didn’t apply because the taxpayers failed to show that IRS engaged in affirmative misconduct or that they were injured by IRS’s conduct. Equitable estoppel is a judicial doctrine that precludes a party from denying his own acts or representations which induced another to act to his detriment. But for the doctrine to apply: (1) the party to be estopped must have made a definite misrepresentation of fact to another person having reason to believe that the other would rely upon it; (2) the party seeking estoppel has to have relied on the misrepresentations to its detriment; and (3) the reliance must have been reasonable, in that the party claiming the estoppel did not know nor should it have known that its adversary’s conduct was misleading.