City disability-pension benefits are tax-free as "in the nature of" workers' comp, but only up to half of pay

Plain-English summary

A city runs a tax-qualified governmental pension plan that pays disability benefits to employees hurt on the job and death benefits to their survivors. The city asked the IRS how those benefits are taxed. The IRS ruled that because the plan limits these benefits to service-connected disabilities and sets them by reference to pay (not age, length of service, or contributions), they count as paid under a statute "in the nature of" a workers' compensation act. That means a disabled worker can exclude the benefit from income under IRC § 104(a)(1), but only up to one-half of the worker's annual pay at the time of disability; anything above that half-pay cap is taxable as an annuity under § 72. Survivor death benefits get the same treatment and cap. Benefits paid to a former spouse under a divorce (domestic relations) order do not qualify for the exclusion and are taxable to the ex-spouse. The rulings apply for 2019 and later years.

Ruling snapshot

• Question: Are the city plan's service-related disability and survivor death benefits excludable from income under § 104(a)(1), and how are amounts above the cap or paid to former spouses treated?
• Outcome: Approved (benefits excludable up to one-half of pay; excess taxable under § 72; former-spouse payments not excludable)
• Key authorities: IRC §§ 104(a)(1), 72, 61; Treas. Reg. § 1.104-1(b); Rev. Rul. 59-269; 80-44; 80-84; 83-91; 85-104; Fernandez v. Commissioner, 138 T.C. 378 (2012)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202035001 Third Party Communication: None
Release Date: 8/28/2020 Date of Communication: Not Applicable
Index Number: 104.00-00, 104.02-00
Person To Contact:
------------------------------------------------------------ ----------------------- ,ID No. -----------------
------------------------ Telephone Number:
------------------------------------------------------------ --------------------
---------------------- Refer Reply To:
------------------------------------------------ CC:EEE:EB:HW
---------------------------------- PLR-119640-19

                                                           Date:
                                                           June 03, 2020

Legend:

Taxpayer = ----------------------------------------------------------------------

Plan = ---------------------------------------------

Statute = --------------------------------------------------------------------------------------------------------

Ordinances = --------------------------------------------------------------------------------------------------

Worker’s Compensation Act = ----------------------------------------------------------------------------

State = ----------------

City = ----------------

Union A = -------------------------------------------------------------------------------------------------------

Union B = -------------------------------------------------------------

Union C = ------------------------------------------------------------------------------------------------------

Union D = ------------------------------------------------------------------------------------------------------

PLR-119640-19 2

Union E = -------------------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

Union F = ----------------------------------------------------------

Union G = ------------------------------------------------------------------------------------------------------

Executive Employee Members = -------------------------------------------------------------------------

Dear -----------------:

This is in reply to a letter dated August 8, 2019, supplemented by a letter dated March
2, 2020, including certain clarifying amendments to the Plan, from your authorized
representative, requesting a ruling on behalf of Taxpayer, concerning the federal
income tax treatment of certain disability and death benefits paid pursuant to Statute
and Ordinances and paid pursuant to Sections --------- and --------- of the Plan.

Taxpayer adopted the Plan pursuant to Statute and Ordinances. Taxpayer represents
that certain benefits are paid under the Plan for eligible employees of City who have
disabilities that arise out of and in the course of employment, in accordance with Statute
and Ordinances. Taxpayer represents that the Plan is a tax-qualified governmental
defined benefit pension plan.

Sections --------- and --------- of the Plan generally correspond to Sections ----- and -------
----- of Ordinances and Sections ------ and --- of Statute.

Section ----- of Ordinances and Section --- of Statute provide, in relevant part, that any
participant receiving payments under the Worker’s Compensation Act will not, at the
same time, receive an annuity provided by the Retirement Fund, except to the extent
that such annuity for each month exceeds the worker’s compensation benefit payable
for the same month.

Section ----- of Ordinances and Section -- of Statute provide, in relevant part, that any
participant who is permanently disabled from performing duties of the nature required by
his or her job, and such disability is shown to the satisfaction of the Retirement Board to
have arisen out of and in the course of his or her employment by the City as defined by
the Worker’s Compensation Act, is eligible for retirement irrespective of the duration of
his or her employment.
PLR-119640-19 3

Section --------- of Ordinances and Section ------- of Statute provide, in relevant part, that
any pension payable by reason of disability arising out of and in the course of
employment as defined in the Worker’s Compensation Act, provided such disability was
not incurred as the result of any other gainful employment, is not less than one-half of
the participant’s annual rate of pay at the time of disability.

Section --------- of Ordinances and Section ------- of Statute provide, in relevant part, that
upon the death of a participant who had been retired by reason of disability, there will be
paid to or on account of his or her surviving child or children under eighteen (18) years
of age, and, in the case of a male participant, to his qualified widow, monthly benefits
consistent with the table set forth in Section --------- of Ordinances and Section ------- of
Statute. Benefits payable under the table are determined based on pay, not based on
the participant’s age, length of service, or prior contributions.

Section -------- of Ordinances and Section ------- of Statute provide, in relevant part, that
upon the death of a participant who has qualified for a disability annuity, a minimum
monthly benefit will be paid to his or her qualified survivors if greater than the amount
determined from the table in Section --------- of Ordinances and Section ------- of Statute.
The minimum monthly benefit is equal to fifty percent (50%) of the amount of the
monthly annuity to which the participant would have been entitled if he or she had been
permanently disabled on the date of his or her death, or fifty percent (50%) of the
amount of his or her actual monthly annuity in the case of a participant who has been
receiving disability benefits from the Fund. The minimum monthly benefit when payable
to a qualified widow without a qualified child or children in her care is further reduced in
amount by two percent (2%) for each year that the age of the widow is less than the age
of the deceased participant.

Section ---- of the Plan provides, in relevant part, that any participant, irrespective of the
duration of his or her employment, who is permanently disabled from performing duties
of the nature required by his or her job which disability arises out of and in the course of
employment by the City is eligible for retirement on account of disability according to the
provisions of Article --.

With respect to participants who are members of Unions A, B, C, D, and E and
Executive Employee Members, Section -------- of the Plan provides, in relevant part, that
any participant who, irrespective of the duration of his or her employment, suffers a
disability which is shown to the satisfaction of the Retirement Board to have arisen out
of and in the course of his or her employment by the City, as defined in the Worker’s
Compensation Act, is entitled to an annuity in an amount determined pursuant to
Section ----; provided satisfactory proof of such disability is submitted to the Retirement
Board. Pursuant to Section -------- of the Plan, if a participant who is a member of Union
C or Union E is separated from service pursuant to the City’s Worker’s Compensation
Return to Work II program, the participant is considered to be disabled as a result of his
or her employment with the City. As such, the participant is automatically eligible for a
PLR-119640-19 4

disability annuity, provided the participant meets all other requirements. Taxpayer
represents that the City’s Worker’s Compensation Return to Work program is only
available to participants who are injured on the job, and part II of the program is for
participants who, after a reasonable period of time, are determined to be unable to
perform the essential functions of their jobs.

With respect to participants who are members of Unions A, B, C, D, and E and
Executive Employee Members, Section -------- of the Plan provides, in relevant part, that
for participants retiring by reason of disability arising out of and in the course of
employment, as defined in the Worker’s Compensation Act, any annuity payable by
reason of such disability is not less than one-half of the participant’s annual rate of Pay
at the time of disability.

With respect to participants who are members of Unions F and G, Section -------- of the
Plan provides, in relevant part, that any participant who, irrespective of the duration of
his or her employment, suffers a disability which is shown to the satisfaction of the
Retirement Board to have arisen out of and in the course of his or her employment by
the City, as defined in the Worker’s Compensation Act, is entitled to an annuity in an
amount determined pursuant to Section ----, provided proof of such disability is
submitted to the Retirement Board.

With respect to participants who are members of Unions F and G, Section -------- of the
Plan provides, in relevant part, that for participants who are determined to be disabled
under Section ----, any annuity payable by reason of disability, provided the disability
was not incurred as the result of any other gainful employment, is not less than one-half
of the participant’s annual rate of Pay at the time of disability.

Section ---- of the Plan provides, in relevant part, that any participant receiving
payments under the Worker’s Compensation Act will not, at the same time, receive an
annuity provided by the Retirement Fund, except to the extent that such annuity for
each month exceeds the Worker’s Compensation benefit payable for the same month.

With respect to participants who are members of Unions A, B, C, D, and E and
Executive Employee Members, Section -------- of the Plan provides, in relevant part, that
upon the death of a participant who had been retired by reason of disability, there will be
paid to or on account of his or her surviving child or children under eighteen (18) years
of age, and to his or her surviving spouse, monthly benefits consistent with the table set
forth in Section --------. Benefits payable under the table are determined based on pay,
not based on the participant’s age, length of service, or prior contributions.

With respect to participants who are members of Unions A, B, C, D, and E and
Executive Employee Members, Section -------- of the Plan provides, in relevant part, that
upon the death of a participant who has qualified for a disability annuity, a minimum
monthly benefit will be paid to his or her qualified survivors if greater than the amount
determined from the table set forth in Section --------. The minimum monthly benefit is
PLR-119640-19 5

equal to fifty percent (50%) of the amount of the monthly annuity to which the participant
would have been entitled if he or she had been permanently disabled on the date of his
or her death, or fifty percent (50%) of the amount of his or her actual monthly annuity in
the case of a participant who has been receiving disability benefits from the Fund.

With respect to participants who are members of Unions F and G, Section -------- of the
Plan provides, in relevant part, that upon the death of a participant who had been retired
by reason of disability, there will be paid to or on account of his or her surviving child or
children under eighteen (18) years of age, and, to his or her surviving spouse, monthly
benefits consistent with the table set forth in Section --------. Benefits payable under the
table are determined based on pay, not based on the participant’s age, length of
service, or prior contributions.

With respect to participants who are members of Unions F and G, Section -------- of the
Plan provides, in relevant part, that upon the death of a participant who has qualified for
a disability annuity, a minimum monthly benefit will be paid to his or her qualified
survivors if greater than the amount determined from the table set forth in Section --------
--------. The minimum monthly benefit is equal to fifty percent (50%) of the amount of the
monthly annuity to which the participant would have been entitled if he or she had been
permanently disabled on the date of his or her death, or fifty percent (50%) of the
amount of his or her actual monthly annuity in the case of a participant who has been
receiving disability benefits from the Fund. The minimum monthly benefit when payable
to a surviving spouse of a participant of Union F without a qualified child or children in
his or her care is further reduced in amount by two percent (2%) for each year that the
age of the surviving spouse is less than the age of the deceased participant.

RULINGS REQUESTED

(1) A service-related disability benefit paid by the Plan to a participant who suffered a
disability arising out of and in the course of the participant’s employment by the City will
be excludable from the participant’s gross income under section 104(a)(1) of the Code
to the extent not exceeding one-half of the participant’s annual rate of pay at the time of
disability.

(2) To the extent, if any, exceeding the amount specified in paragraph (1), the service-
related disability benefit will be gross income to the participant under section 72 of the
Code.

(3) Death benefits paid by the Plan to a survivor of a deceased disabled participant will
be excludable from the recipient’s gross income under section 104(a)(1) of the Code to
the extent not exceeding the greater of: (a) a fixed amount stated in the Plan; or (b) one-
half of the monthly disability benefit for which the participant had been qualified or was
receiving at the time of the participant’s death; provided, in either case, that the
Retirement Board determined that the participant’s disability arose out of and in the
course of the participant’s employment by the City.
PLR-119640-19 6

(4) Disability benefits and death benefits paid under the Plan to former spouses of
participants pursuant to domestic relations orders are not excludable from the gross
income of former spouses under section 104(a) of the Code.

(5) The foregoing rulings are prospective and, based on the Plan’s representation of no
changes to the service-related disability benefit in recent years, also retroactive to 2019
service-related disability benefit payments.

Under State law, the parties may specifically provide in a domestic relations order that
the former spouse will receive a share of a disability benefit, and the Taxpayer will
follow that direction.

Section 61(a) of the Code provides that, except as otherwise provided, gross income
means all income from whatever source derived, including compensation for services.

Section 72(a) of the Code provides that, except as otherwise provided, gross income
includes any amount received as an annuity (whether for a period certain or during one
or more lives) under an annuity, endowment or life insurance contract.

Section 104(a)(1) of the Code provides that gross income does not include amounts
received under workmen’s compensation acts as compensation for personal injuries or
sickness.

Section 1.104-1(b) of the Income Tax Regulations states that section 104(a)(1) of the
Code excludes from gross income amounts received by an employee under a
workmen’s compensation act or under a statute in the nature of a workmen’s
compensation act that provides compensation to the employee for personal injury or
sickness incurred in the course of employment. Section 104(a)(1) also applies to
compensation which is paid under a workmen’s compensation act to the survivor or
survivors of a deceased employee. Section 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. Section 104(a)(1) also
does not apply to amounts which are received as compensation for a non-occupational
injury or sickness nor to amounts received as compensation for an occupation injury or
sickness to the extent that they are in excess of the amount provided in the applicable
workmen’s compensation act or acts.

When a disability benefit is determined to be in the nature of workmen’s compensation,
benefits paid thereunder will be excluded in full pursuant to section 104(a)(1), even
though such benefits exceed those payable under the state’s general workmen’s
compensation act. See, Rev. Rul. 59-269, 1959-2 C.B. 39; Rev. Rul. 83-91, 1983-1 C.B.
38.
PLR-119640-19 7

In Revenue Ruling 80-44, 1980-1 C.B. 34, a statute in the nature of a workmen’s
compensation act provided for an allowance of the greater of (A) 60 percent of the
individual’s average final compensation, or (B) the amount to which the individual would
be entitled under the normal, years of service, retirement plan. The ruling concluded
that the benefits under the statute were excludable under section 104(a)(1) of the Code
to the extent that they did not exceed 60 percent of the final average compensation.

Any excess over 60 percent of final average compensation was attributable to length of
service, and therefore, not excludible from gross income. Rev. Rul. 80-44 also holds
that benefits of the surviving spouse which are a continuation of the employee’s benefits
are excludible under section 104(a)(1) of the Code in the same percentage as the
employee’s benefits were excludible.

Rev. Rul. 80-84, 1980-1 C.B. 35, concluded that benefits paid to employees’ survivors
may qualify as paid under a statute in the nature of a workmen’s compensation act
where those benefits are a mere continuation of employees’ section 104(a)(1) benefits.
The ruling also stated that a statute authorizing benefits for employees’ survivors may
qualify as a statute in the nature of a workmen’s compensation act if it requires as a
prerequisite to payment a determination that the cause of the employee’s death was
service-related. The ruling concluded that survivor benefits are excludable from gross
income under section 104(a)(1) of the Code if the recipient can establish that the
benefits are received under the service-connected death provisions.

Rev. Rul. 85-104, 1985-2 C.B. 52, considered a statute under which the participants
who were disabled due to work-related injury or sickness, receive the greater of a fixed
percentage of base salary or an amount computed on the basis of years of service. The
ruling concluded that an amount up to the percentage of base salary specified by the
statute would be excludible from the participant’s gross income under section 104(a)(1)
of the Code but that any excess, computed on the basis of length of service, would not
be excludible under section 104(a)(1). The ruling also concluded that if benefits are
computed by a formula that does not refer to the employee’s age, length of service, or
prior contributions and are provided to a class that is restricted to employees with
service-incurred injuries, then the benefits are payment for those injuries, and the
statute under which the benefits are paid qualifies as a statute in the nature of a
workmen’s compensation act.

Sections ------ and --- of Statute and Sections ----- and ----------- of Ordinances limit
benefits to employees who suffer disabilities that arise out of and in the course of
employment, and the benefits are not determined based on the employee’s age, length
of service, or prior contributions. Thus, Sections ------ and --- of Statute and Sections ---
----- and ----------- of Ordinances are in the nature of a workmen’s compensation act.

Disability benefits are paid under the Plan pursuant to Sections ------ and --- of Statute
and Sections ----- and ----------- of Ordinances to a participant where the disability arises
out of and in the course of employment, or upon the death of a participant who had
PLR-119640-19 8

been determined to be disabled by reason of disability that arose out of and in the
course of employment, and are thus in the nature of workmen’s compensation. The
minimum disability benefits are determined by reference to rate of pay, not by reference
to the participant’s age, length of service, or prior contributions.

To the extent the disability retirement benefit paid under the Plan to a participant who
suffers a disability that arises out of and in the course of employment exceeds the
minimum disability benefit that is not determined by reference to the participant’s age,
length of service, or prior contributions, the excess is includable as taxable gross
income under section 72. To the extent the death benefit paid under the Plan to a
survivor of a deceased participant who had suffered a disability that arose out of and in
the course of employment exceeds the minimum disability benefit that is not determined
by reference to the participant’s age, length of service, or prior contributions, the excess
is includable as taxable gross income under section 72.

Section 104(a)(1) is strictly construed in a manner consistent with section 61, which
provides that all income is included in gross income unless explicitly excluded.
Moreover, section 1.104-1 of the regulations explicitly limits the exclusion from income
to employees and their survivors. Neither the Code nor the regulations provide an
exclusion from income for amounts paid to former spouses pursuant to a domestic
relations order. See, Fernandez v. Comm’r, 138 T.C. 378 (2012).

Based on the representations made by Taxpayer and the authorities cited above, we
conclude as follows:

(1) Benefits paid under the Plan to participants who are members of Unions A, B, C, D,
E, F, and G and Executive Employee Members for disabilities that arise out of and in
the course of employment will not be gross income to the recipient under section
104(a)(1) of the Code to the extent that the benefits do not exceed 50% of the
participant’s annual rate of pay at the time of disability.

(2) Any portion of the benefit paid under the Plan to participants who are members of
Unions A, B, C, D, E, F, and G and Executive Employee Members for disabilities that
arise out of and in the course of employment that exceeds 50% of the participant’s
annual rate of pay at the time of disability will be gross income to the recipient under
section 72 of the Code.

(3) Benefits paid under the Plan to survivors of deceased participants who were
members of Unions A, B, C, D, E, F, and G and Executive Employee Members and who
were receiving disability benefits due to disabilities that arise out of and in the course of
employment, will not be gross income to the recipient under section 104(a)(1) of the
Code to the extent that the death benefits do not exceed the greater of: (a) a fixed
amount stated in the Plan that is determined by reference to pay, not by reference to
age or length of service, or (b) 50% of the monthly disability benefit for which the
participant had been qualified or was receiving at the time of the participant’s death, but
PLR-119640-19 9

only to the extent that (a) and (b) do not exceed 50% of the participant’s annual rate of
pay at the time of disability. Any portion of the death benefit that exceeds that amount
will be gross income to the survivor under section 72 of the Code.

(4) Disability benefits and death benefits paid under the Plan to former spouses of
participants pursuant to eligible domestic relations orders are not excludable from the
taxable income of former spouses under section 104(a)(1) of the Code.

(5) Pursuant to section 5.01 of Rev. Proc. 2020-1, 2020-01 I.R.B. 1, this ruling is
effective for taxable years 2019 and later.

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal tax consequences under any other provision of the Code or regulations or
Statute and Ordinances, other than those specifically stated above.

These rulings are directed only to the taxpayer who requested them. Section 6110(k)(3)
of the Code provides that they may not be used or cited as precedent.

                                  Sincerely,




                                  Denise Trujillo, Branch Chief
                                  Health & Welfare Branch
                                  Office of Associate Chief Counsel
                                  (Employee Benefits, Exempt Organizations,
                                  and Employment Taxes)

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