                  T.C. Summary Opinion 2001-136



                     UNITED STATES TAX COURT



            D. LLOYD AND BETTY THOMAS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3672-00S.                Filed September 5, 2001.


     D. Lloyd and Betty Thomas, pro sese.

     Elizabeth Owen, for respondent.


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

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.1   The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority.



     1
       All subsequent section references are to the Internal
Revenue Code in effect for 1997, the taxable year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 2 -

     Respondent determined a deficiency in petitioners’ Federal

income tax for 1997 in the amount of $1,564.

     After concessions by the parties,2 the issues for decision

are as follows:

     (1) Whether petitioners may exclude from gross income

disability benefits received by petitioner D. Lloyd Thomas.    We

hold that petitioners may exclude such benefits.

     (2) Whether petitioners received interest on an overpayment

of income tax for 1993.   We hold that petitioners received such

interest.

Background

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

found.   Petitioners resided in Copperas Cove, Texas, at the time

that their petition was filed with the Court.

     At all relevant times, petitioners utilized the cash

receipts and disbursements method of accounting in computing

their taxable income.   See sec. 446(c)(1).



     2
        Petitioners concede that in 1997 they were credited with
interest on overpayments of income tax for 1992, 1994, and 1995
in the amounts of $49.86, $161.84, and $7.03, respectively, as
determined by respondent in the notice of deficiency.
     Respondent concedes that the deficiency determined in the
notice of deficiency ($1,564) is overstated because of a
computational error and that the correct amount of the deficiency
is $1,451.
     The parties agree that adjustments to petitioners’ IRA
deduction and Schedule A deductions are computational matters,
the resolution of which depends on our disposition of the two
disputed issues identified above.
                               - 3 -

     A. Disability Benefits

     Petitioner D. Lloyd Thomas (petitioner) was employed by the

Texas Department of Criminal Justice as an associate clinical

psychologist from August 1994 through February 1999.

     In or about February 1997, petitioner suffered a herniated

disk.   Petitioner’s injury was sufficiently severe as to require

bed rest and home confinement for a continuous period of time

that extended through July 1997.

     During the first 2 months of his 6-month absence from work,

petitioner utilized his accumulated sick leave and annual leave.

After exhausting his leave, petitioner began receiving disability

benefits.   For the period from April 2 through July 30, 1997,

petitioner received disability benefits in the amount of $4,964.

     Petitioner received disability benefits pursuant to a plan

of disability insurance that was sponsored by his employer.

However, the premiums for such insurance were paid solely by

petitioner with after-tax dollars.     In this regard, petitioner

specifically elected, in August 1994, not to pay the premiums for

disability insurance with pre-tax dollars pursuant to “premium

conversion”.   This election remained in effect throughout 1997.

     Petitioners did not report on their Federal income tax

return the disability benefits received by petitioner in 1997.

In the notice of deficiency, respondent determined that such

benefits were includable in petitioners’ gross income for the
                                    - 4 -

year in issue.

     B. Interest Income

     Petitioners overpaid their income tax for 1993.               After a

portion of the overpayment was apparently paid to another Federal

agency, see sec. 6402(d), a balance of $1,077.98 remained as a

credit in petitioners’ account.         Of this amount, $726.39 was

subsequently applied against petitioners’ Federal income tax

liability for 1996, thereby leaving a balance of $351.59.               In

this regard, petitioners received a notice from respondent dated

October 6, 1997, explaining how respondent applied the

overpayment.     This notice stated, in part, as follows:

                        How We Applied Your Overpayment

         Amount Of Overpaid Tax On Your Return . . . .   . $1,077.98
         Amount Of Interest You Earned on Overpayment.   .      $.00
         Total Amount Due You . . . . . . . . . . . .    . $1,077.98
         Total Amount Applied . . . . . . . . . . . .    .   $726.39

         Amount You Will Receive As A Refund . . . . . .    $351.59
         (Any Interest Due You Will Be Added)


     On or about October 6, 1997, respondent issued a refund

check to petitioners in the amount of $663.43.              This amount

consisted of tax in the amount of $351.59 and interest in the

amount of $311.84.3



     3
        Respondent’s transcript of petitioner’s account for 1993
shows that petitioners were credited with interest on the
overpayment for 1993 as follows:


                                                                (continued...)
                                - 5 -

     Petitioners reported no interest income on their 1997

Federal income tax return.    Respondent determined that

petitioners received interest in 1997 in the amount of $311.84 on

their overpayment of income tax for 1993.

Discussion

     A. Disability Benefits

     As a general rule, section 104(a)(3) excludes from an

employee's gross income amounts received through accident or

health insurance for personal injuries or sickness.     However, the

section provides an exception for amounts received by an employee

to the extent such amounts either are paid by the employer or are

attributable to employer contributions that were not includable

in the employee's gross income.4

     Section 105(a) coordinates with section 104.      Rabideau v.

Commissioner, T.C. Memo. 1997-230.      As a general rule, section

105(a) provides that amounts received by an employee through



     3
      (...continued)
                Date             Amount
               4/15/97          $196.41
               8/25/97             0.04
               10/6/97           115.39
                                 311.84
     4
       See Trappey v. Commissioner, 34 T.C. 407 (1960)
(disability income is received through accident or health
insurance for personal injuries or sickness within the meaning of
sec. 104(a)(3)); see also sec. 105(e)(1) (for purposes of secs.
104 and 105, amounts received under an accident or health plan
for employees are treated as amounts received through accident or
health insurance); Chernik v. Commissioner, T.C. Memo. 1999-313.
                               - 6 -

accident or health insurance for personal injuries or sickness

shall be included in gross income to the extent such amounts are

either paid by the employer or are attributable to contributions

by the employer that were not included in the employee's gross

income.

     At trial, we had the opportunity to observe petitioner,

evaluate his demeanor, and assess his credibility.   We found

petitioner to be a credible witness, and we have no reason to

question his veracity.   Petitioner's testimony provides the

evidentiary basis for our finding that petitioner specifically

elected, in August 1994, not to pay the premiums for his

disability insurance with pre-tax dollars pursuant to “premium

conversion”.

     On brief, respondent states as follows:

          The determinative factual issue in this case is
     whether the premiums were contributed by petitioner on
     a pre-tax or after-tax basis. If they were paid out of
     pre-tax monies as respondent contends, then the
     disability benefits received by petitioner would be
     taxable. If, on the other hand, the disability
     insurance premiums were paid out of after-tax dollars
     as petitioners contend, then the disability benefits
     received by petitioner would not be taxable.

     In view of our finding that petitioner paid the premiums for

his disability insurance with after-tax dollars, we hold that the

disability benefits received by petitioner in 1997 are excludable

from gross income for that year.   Sec. 104(a)(3).   Accordingly,

respondent’s determination to the contrary is not sustained.
                                - 7 -

     B. Interest Income

     Petitioners admitted at trial that they received a refund

check from respondent in 1997 and that such check pertained to

the taxable year 1993.    However, petitioners contend that they

did not receive any interest.    In this regard, petitioners rely

on that part of the respondent’s notice dated October 6, 1997,

stating:    “Amount Of Interest You Earned on Overpayment ...

$.00".   According to petitioners, this statement demonstrates

that they neither received nor were credited with any interest on

their 1993 overpayment of income tax.    We disagree.

     Petitioners read the notice dated October 6, 1997,

myopically.    That notice clearly states that in addition to the

$351.59 of tax that petitioners would receive as a refund, “Any

Interest Due You Will Be Added”.    In that regard, the record

clearly demonstrates that respondent did, in fact, “add” interest

to petitioners’ refund, specifically $311.84, which was part of

the $663.43 check that was issued on or about October 6, 1997.

Accordingly, we hold that petitioners failed to report interest

income in the amount of $311.84.    Respondent’s determination is

sustained.

     Reviewed and adopted as the report of the Small Tax Case

Division.
                              - 8 -

     In order to give effect to our disposition of the disputed

issues, as well as the parties’ concessions,



                                        Decision will be entered

                                   under Rule 155.
