                  T.C. Summary Opinion 2009-131



                     UNITED STATES TAX COURT



             JEREMIAH FRANCIS O’NEILL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6708-08S.                Filed August 25, 2009.



     Jeremiah Francis O’Neill, pro se.

     Joan M. Casali, for respondent.




     ARMEN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.1   Pursuant to section

7463(b), the decision to be entered is not reviewable by any


     1
        Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for the
taxable years in issue.
                               - 2 -

other court, and this opinion shall not be treated as precedent

for any other case.

     Petitioner received a notice of deficiency for 2004, 2005,

and 2006 in which respondent determined:   (1) Deficiencies in

income taxes of $5,894, $6,146, and $6,313, respectively, and (2)

accuracy-related penalties under section 6662(a) for substantial

understatement of income tax of $1,179, $1,229, and $1,263,

respectively.   The issues for decision are:   (1) Whether

petitioner may exclude from gross income payments received from

the New York City Fire Department Pension Fund; and (2) whether

petitioner is liable for the accuracy-related penalty under

section 6662(a) for each of the years at issue.    We hold that

petitioner may not exclude said payments and that he is not

liable for the penalties.

                            Background

     Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and accompanying exhibits.

     When the petition was filed, petitioner resided in the State

of New York.

     From January 1955 until May 1976 petitioner was employed by

the City of New York.   Petitioner began his tenure with the City

of New York as a police officer, but after 2 years he transferred

to the fire department, where he served as a firefighter for the
                                 - 3 -

remaining 19 years.   At the time petitioner transferred to the

fire department, the New York City Fire Department, Article 1-B

Pension Fund (Pension Fund) assumed liability for any retirement

earnings he had accumulated as a police officer.    See N.Y. City

Admin. Code secs. 13-301 through 13-379.1 (2009).   The Pension

Fund required members to contribute a specified amount through

payroll deductions determined by the member’s age at appointment.

Upon the member’s 20th anniversary these mandatory contributions

ceased.   During the course of his employment with the City of New

York, petitioner contributed $5,894.46 to the Pension Fund.

     In addition to the mandatory member contributions, the City

of New York contributed a small amount on behalf of each member

as well as an additional larger amount to maintain the overall

integrity of the Pension Fund.    The Pension Fund did not maintain

separate member accounts and did not distinguish between employer

and employee contributions with respect to the categories of

retirement.   Instead, the Pension Fund pooled all of the

contributions into a contingency reserve fund.

     The Pension Fund provided three categories of retirement:

Regular service, ordinary disability, and accidental disability.

The amount of benefit received depended upon the category under

which the member retired.

     Regular service retirement was available to all members

after 20 years of service, regardless of the member’s age, and
                               - 4 -

the benefit was determined on the basis of the member’s final

compensation and years of service.     A member could continue in

service after the 20 years, but had to retire by the age of 65.

     Ordinary disability retirement was available when the member

became physically or mentally incapacitated from the performance

of duty as a result of a non-service-incurred disability.      The

Pension Fund determined the amount of benefit on the basis of the

member’s final compensation and number of years of service.

     Accidental disability retirement was available when a member

became physically or mentally incapacitated from the performance

of service as a result of a service-incurred disability.      The

amount of benefit was equal to three-quarters of the member’s

final compensation.   In the case of both ordinary and accidental

disability retirement, the nature and severity of the injury did

not determine the amount of benefit that the retiring member

received.

     Petitioner received ordinary disability retirement from the

Fire Department commencing in 1976.     At trial petitioner

explained the nature of his disability, stating that while

serving in the Armed Forces during the Korean War he injured his

hand and that this injury left him more susceptible to injuring

his foot when mounting and dismounting a fire truck.

     After considering petitioner’s condition, the New York City

Fire Department’s Bureau of Accounts and Procurement recommended
                                 - 5 -

that petitioner be granted ordinary disability retirement.       As a

result, on May 28, 1976, the Board of Trustees of the Pension

Fund directed the retirement of petitioner for a “Non-Service

Incurred Disability” with a retirement date of May 29, 1976.

      In 2004, 2005, and 2006, petitioner received payments from

the Pension Fund of $34,323.96, $34,539.96, and $34,833.96,

respectively.     Petitioner did not report these amounts on his

returns for those years.     It was (and still is) petitioner’s

position that these payments were tax-free pension insurance

payments received as a result of his premium payments of

$5,894.46 made during his tenure with the City of New York.

                              Discussion

A.   Includability of Pension Fund Payments

      Section 61(a) provides generally that “gross income means

all income from whatever source derived”.       Gross income is an

inclusive term with broad scope, designed by Congress to “exert

* * * ‘the full measure of its taxing power.’”       Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 429 (1955) (quoting Helvering

v. Clifford, 309 U.S. 331, 334 (1940)).       Section 61 specifically

includes annuities and pensions as items of gross income.       Sec.

61(a)(9), (11).

     Statutory exclusions from income are matters of legislative

grace and are narrowly construed.        Commissioner v. Schleier, 515

U.S. 323, 328 (1995).     Taxpayers seeking an exclusion from income
                               - 6 -

must demonstrate they are eligible for the exclusion and bring

themselves “within the clear scope of the exclusion.”     Dobra v.

Commissioner, 111 T.C. 339, 349 n.16 (1998).

     The taxation of disability retirement benefits, such as

those paid to petitioner under the Pension Fund, requires

examination of sections 72, 104, and 105, and the regulations

thereunder.

     Section 72(a) generally includes in gross income any amount

received as an annuity under an annuity, endowment, or life

insurance contract.   Section 72(b) provides an exclusion from

gross income of an amount proportionate to the taxpayer’s

investment in the contract limited to the taxpayer’s unrecovered

investment in the contract.   Section 72(c) defines the investment

in the contract as the aggregate amount of premiums or other

consideration paid for the contract.

     If petitioner’s disability retirement benefits are

considered received under an annuity, endowment, or life

insurance contract, the general rule includes the amounts

received in gross income, but section 72(b) excludes a portion on

the basis of petitioner’s investment in the contract.   However,

for taxpayers whose annuity starting date was on or before July

1, 1986, section 72(d) provided a 3-year basis recovery rule.2

     2
        This provision was repealed by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1122(c)(1), (h)(1)-(7), 100 Stat.
                                                   (continued...)
                                - 7 -

Under this provision, if the taxpayer would recover his total

contribution in the first 3 years of his annuity, then he could

exclude all amounts received under the contract until there had

been so excluded an amount equal to the taxpayer’s contribution.

All amounts received thereafter would be includable in gross

income.   Id.

      Petitioner retired in 1976, and although it is unclear what

amount, if any, he received in 1976, he received disability

retirement benefits in 1977 of $17,303.04.   Because the amount

received in 1977 exceeded petitioner’s total contributions of

$5,894.46 and was within the 3-year period, he was eligible to

exclude his contributions to the Pension Fund from his taxable

income for taxable year 1977.   All subsequent payments were to be

included in petitioner’s gross income.

B.   Exclusion Provisions of Sections 104 and 105

      Section 72 applies to “a pension plan * * * which provides

for the payment of pensions at retirement and the payment of an

earlier pension in the event of permanent disability.”   Sec.

1.72-15(a), Income Tax Regs.    However, section 72 does not apply

to any amount received as an accident or health benefit, and the

tax treatment of any such amount is determined under sections 104


      2
      (...continued)
2467, 2470, as amended by the Technical and Miscellaneous Revenue
Act of 1988, Pub. L. 100-647, sec. 1011A(b)(2)(A), (12)-(15) 102
stat. 3472, 3474.
                                - 8 -

and 105.    Sec. 1.72-15(b), Income Tax Regs.   Thus, generally

speaking, “the framework established under section 72 applies

where no exclusion is available under section 104 or 105.”

Wright v. Commissioner, T.C. Memo. 2005-5.      We turn therefore to

the exclusions provided by sections 104 and 105.

     Section 104(a), in relevant part, excludes from gross income

certain amounts received as compensation for injuries or sickness

described in paragraphs (1) through (4).3    Section 105(a)

includes in gross income certain amounts received under accident

and health plans for personal injuries or sickness, subject to

two exceptions.

     Although petitioner argues that his disability retirement

benefits are excludable from income, the record clearly

establishes that the amounts he received do not qualify for any

of the exclusions of sections 104 and 105.

     Section 104(a)(1) excludes from gross income “amounts

received under workmen’s compensation acts as compensation for

personal injuries or sickness”.    However, section 104(a)(1) “does

not apply to amounts which are received as compensation for

nonoccupational injury or sickness”.    Sec. 1.104-1(b), Income Tax

Regs.    Thus, a statute will not be considered a workmen’s

compensation act if it allows for disability payments for reasons

     3
        Par. (5) of sec. 104(a), which applies to victims of
terrorist attacks, is on its face inapplicable to the facts
before us.
                               - 9 -

other than service-incurred injuries.   Haar v. Commissioner, 78

T.C. 864, 868 (1982) (citing Riley v. United States, 140 Ct. Cl.

381, 156 F. Supp. 751 (1957)), affd. 709 F.2d 1206 (8th Cir.

1983).

     The Pension Fund established by the Administrative Code of

the City of New York provided disability payments for both

service- and non-service-incurred injuries.   The resolution

adopted by the Board of Trustees of the Pension Fund on May 28,

1976, awarded retirement benefits to petitioner on account of a

non-service-incurred disability.   These benefits are, therefore,

not excludable from gross income under section 104(a)(1).

     Section 104(a)(2) excludes from gross income damages

“received (whether by suit or agreement * * *) on account of

personal physical injuries or physical sickness”.   “The term

‘damages received (whether by suit or agreement)’ means an amount

received * * * through prosecution of a legal suit or action

based upon tort or tort type rights, or through a settlement

agreement entered into in lieu of such prosecution.”   Sec. 1.104-

1(c), Income Tax Regs.   Thus, “The essential element of an

exclusion under 104(a)(2) is that the income involved must derive

from some sort of tort claim against the payor.”    Glynn v.

Commissioner, 76 T.C. 116, 119 (1981), affd. without published

opinion 676 F.2d 682 (1st Cir. 1982).
                                - 10 -

     The ordinary disability retirement benefits provided under

the Pension Fund were not payments derived from a tort claim

against the City of New York.    Rather, such payments were made to

petitioner as a result of a prior employment relationship with

the City and were calculated on the basis of his years of service

and final compensation.    Consequently, the benefits petitioner

received are not excludable from gross income under section

104(a)(2).

     Section 104(a)(3) generally excludes from gross income

amounts received by an employee through employer-provided

accident or health insurance for personal injuries or sickness.

This exclusion does not apply if the amounts received are

attributable to employer contributions that were not includable

in the gross income of the employee, or were paid by the

employer. Id.     If an employer and his employees contribute to a

fund or purchase insurance that pays accident or health benefits

to employees, section 104(a)(3) does not apply to amounts

received thereunder to the extent that such amounts are

attributable to the employer’s contributions.    Sec. 1.104-1(d),

Income Tax Regs.    “[I]n the case of a retirement plan to which an

employee is required to contribute, it is presumed that the

accident and health benefits are funded by employer

contributions.”     Bagnell v. Commissioner, T.C. Memo. 1993-378

(citing Chosiad v. Commissioner, T.C. Memo. 1980-408).     Moreover,
                                - 11 -

unless the plan expressly provides otherwise, the law presumes a

contributing plan that provides both disability and retirement

benefits sources the disability benefits in employer

contributions.   Id.

     The Pension Fund required petitioner to contribute, provided

both disability and retirement benefits, and contained no express

provision on the source of the disability benefits.     Therefore,

the benefits received by petitioner are not excludable under

section 104(a)(3).

     Section 105 is the mirror image to section 104(a)(3) but

provides two exceptions to includability.     Section 105(b)

provides an exclusion for amounts paid by an employer to the

taxpayer to reimburse the taxpayer for expenses for medical care.

Medical expenses are not at issue in this case, so the exception

in section 105(b) does not apply.

     Section 105(c) excludes from gross income amounts

attributable to employer contributions to the extent such amounts

(1) constitute “payment for the permanent loss or loss of use of

a member or function of the body, or the permanent disfigurement,

of the taxpayer, * * * and (2) are computed with reference to the

nature of the injury without regard to the period the employee is

absent from work.”     Courts have interpreted section 105(c) to

exclude payments from gross income only if the plan or contract

under which such payments are made varies the amount of the
                                - 12 -

payments according to the type and severity of the injury

suffered by the employee.    Beisler v. Commissioner, 814 F.2d

1304, 1307 (9th Cir. 1987), affg. T.C. Memo. 1985-25.

     The Pension Fund’s computation of an ordinary disability

retirement benefit did not vary with the nature of the

disability.    Instead, the Pension Fund determined the member’s

benefit on the basis of final compensation and years of service.

Thus, the exception under section 105(c) does not apply.

     Returning now to section 104, subsection (a)(4) excludes

from gross income amounts received for injuries or sickness

resulting from active service in the Armed Forces.      Determining

whether the injury or sickness resulted from active service in

the Armed Forces requires examining the underlying provision upon

which the benefits are predicated.       Haar v. Commissioner, supra

at 866.   If the provisions consider solely the employee’s ability

to perform his or her job, and the nature or cause of the injury

is irrelevant, then whether the injury arose in military service

is simply not a factor.     Id. at 866-867.

     Although petitioner incurred an injury while serving in the

Korean War that contributed to the later injury of his foot, the

ordinary disability retirement provision of the Pension Fund

considered only his ability to perform the duties of a

firefighter.    Therefore, the nature or cause of the injury was
                                 - 13 -

irrelevant, and petitioner does not satisfy the requirements of

section 104(a)(4).

      On the basis of foregoing, petitioner is not entitled to

exclude from gross income the ordinary disability retirement

benefits he received from the New York City Fire Department,

Article 1-B Pension Fund.      Accordingly, we hold that the ordinary

disability retirement benefits petitioner received in 2004, 2005,

and 2006 constitute gross income for each year.

C.   Section 6662(a) Penalty

      Section 6662(a) and (b)(2) imposes a penalty equal to 20

percent of the amount of any underpayment attributable to a

substantial understatement of income tax.     An understatement of

income tax is substantial if the understatement exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000.    Sec. 6662(d)(1)(A).   The definition of

understatement for this purpose is the excess of the tax required

to be shown on the return over the tax actually shown on the

return.   Sec. 6662(d)(2)(A).

      Tax is not understated to the extent that (1) the taxpayer

bases treatment of the item on substantial authority, or (2) the

taxpayer adequately discloses the item in the return or in a

statement attached to the return and the taxpayer has a

reasonable basis for the tax treatment of such item.     Sec.

6662(d)(2)(B).   Further, the penalty is inapplicable with respect
                             - 14 -

to any part of an underpayment if it is shown that there was

reasonable cause for such position and that the taxpayer acted in

good faith with respect to such position.    Sec. 6664(c)(1).   The

Commissioner bears the burden of production, sec. 7491(c), but,

if satisfied, the taxpayer then bears the ultimate burden of

persuasion, Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

     Although the issue is a close one, we are satisfied, after

considering the totality of the facts and circumstances, that

petitioner acted in good faith and comes within the reasonable

cause exception of section 6664(c)(1).   Accordingly, we hold that

petitioner is not liable for the accuracy-related penalties.

                           Conclusion

     We have considered all of the arguments made by petitioner,

and, to the extent that we have not specifically addressed them,

we conclude that they are without merit.

     To reflect the foregoing,




                                           Decision will be entered

                                   for respondent as to the

                                   deficiencies in taxes and for

                                   petitioner as to the accuracy-

                                   related penalties.
