Tax Court in Brief | Servance v. Comm’r | Tier 1 Railroad Retirement Benefits, Claim-of-Right Doctrine, Rescission Doctrine

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The Tax Court in Brief – November 21st – November 25th, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation:  The Week of November 21st, 2022, through November 25th, 2022

Servance v. Comm’r, T.C. Summary Opinion 2022-23 | November 21, 2022 |Copeland, J.| Dkt. No. 1587-18S (Tier 1 Railroad Retirement Benefits; Claim-of-Right Doctrine; Rescission Doctrine)

Summary: In 2012, Elijah Servance retired from the Metro-North Railroad. Mr. Servance applied for long-term disability benefits from the U.S. Railroad Retirement Board (RRB), and his application was granted in December 2012. During 2015 the RRB paid Mr. Servance tier 1 railroad retirement benefits and reported these benefits on Form SSA–1099, Social Security Benefit Statement, issued to Mr. Servance. The Servances (Elijah and Corliss) did not report the tier 1 railroad retirement benefits on their joint 2015 federal income tax return. Mr. Servance was eligible for benefits under a long-term disability insurance policy. Premiums were paid by Metro-North. The Servances did not report receipt of any Hartford Life Insurance (Hartford) long-term disability payments on their 2015 federal tax return. The IRS compared the Servances’ 2015 federal income tax return to the third-party reports it received and, on the basis of these comparisons, issued a notice of deficiency to the Servances.

Key Issue: Whether the Servances’ gross income includes unreported tier 1 railroad retirement benefits paid to Servance during 2015? Whether the Servances’ gross income includes unreported long-term disability payments of purportedly made by Hartford during 2015?

Primary Holdings: The Servances are not entitled to exclude Mr. Servance’s tier 1 railroad retirement benefits from gross income (other than the 15% excluded by 26 U.S.C. § 86). As for the Hartford LTD payments, the IRS failed to meet a threshold burden of demonstrating that the Servances actually received any taxable income from Hartford in 2015, and the Servances showed that they did not have any such accretion to wealth.

Key Points of Law: Pursuant to 26 U.S.C. § 7463(b), this decision is not reviewable by any other court, and the opinion shall not be treated as precedent for any other case.

Burdens of Proof. Generally, the IRS’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that the IRS’s determinations are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In cases of unreported income, the IRS must establish an evidentiary foundation connecting the taxpayer to the income-producing activity, or otherwise demonstrate that the taxpayer actually received income. See Edwards v. Commissioner, 680 F.2d 1268, 1270–71 (9th Cir. 1982); Weimerskirch v. Commissioner, 596 F.2d 358, 361–62 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). The presumption of correctness does not apply if the notice of deficiency is unsupported by any significant evidence. Schaffer v. Commissioner, 779 F.2d 849, 858 (2d Cir. 1985), aff’g in part and remanding in part Mandina v. Commissioner, T.C. Memo. 1982-34. Once the IRS makes the required threshold showing, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner’s determinations are arbitrary or erroneous. See Williams v. Commissioner, 999 F.2d 760, 763 (4th Cir. 1993), aff’g T.C. Memo. 1992-153.

Section 104. Section 104(a)(1) excludes “amounts received under workmen’s compensation acts as compensation for personal injuries or sickness.” Treasury Regulation § 1.104-1(b) extends the exclusion to amounts paid “under a statute in the nature of a workmen’s compensation act which provides compensation to employees for personal injuries or sickness incurred in the course of employment.” Amounts received as compensation for a “non-occupational injury” do not qualify for the exclusion. Id.

Tier 1 Railroad Retirement Benefits.  45 U.S.C. § 231a authorizes tier 1 railroad retirement benefits for current and former U.S. railroad workers.  Some of the eligibility categories under that statute refer to disability, but none require that the disability have been incurred in the course of the recipient’s railroad work. Id.  45 U.S.C. § 231a is neither a workmen’s compensation act nor a statute “in the nature of” a workmen’s compensation act, as none of its eligibility criteria includes an on-the-job injury or sickness. A statute will not be treated as similar to a workers’ compensation act if it allows for disability payments for any reason other than on-the-job injuries.  See, e.g., Haar v. Commissioner, 78 T.C. 864, 868 (1982), aff’d, 709 F.2d 1206 (8th Cir. 1983).

Social Security Benefits. 26 U.S.C. § 86(a) generally includes a portion of Social Security benefits in gross income, and section 86(d)(1)(B) explicitly includes tier 1 railroad retirement benefits within the meaning of “social security benefits” for this purpose. Per section 86, recipients of tier 1 railroad retirement benefits typically must include only 85% of the benefits received as gross income.

Claim-of-Right Doctrine. According to the claim-of-right doctrine, if a taxpayer receives a payment under a claim of right and without restrictions, he must include that payment in gross income for the year of receipt, even if he might later be obligated to return it. James v. United States, 366 U.S. 213, 219 (1961); N. Am. Oil. Consol. v. Burnet, 286 U.S. 417, 424 (1932).

Rescission Doctrine. The rescission doctrine is an exception to the claim-of-right doctrine. Under the rescission doctrine, even if a taxpayer receives a payment under a claim of right, the taxpayer need not report it if the taxpayer’s right to the amount is rescinded and within the year of receipt, the parties to the payment are restored “to the relative positions that they would have occupied had no contract been made.” Blagaich v. Commissioner, T.C. Memo. 2016-2, at *13.

Proof of Benefit. Generally, when a third-party document simply contradicts (without any supporting evidence) a taxpayer’s assertion that he did not receive income, that document does not suffice for the Tax Court to rely on the presumption of correctness normally afforded to a notice of deficiency. See Portillo v. Commissioner, 932 F.2d 1128, 1134 (5th Cir. 1991) (holding that a third-party Form 1099 did not, without 6 more, satisfy the presumption of correctness regarding alleged unreported income), aff’g in part, rev’g in part T.C. Memo. 1990-68.

Insights. The workers’-comp-related income exclusion set forth in section 104 does not apply for amounts received as compensation for a “non-occupational injury”. 26 U.S.C. § 86 generally includes a portion of Social Security benefits in gross income, and the statute explicitly includes tier 1 railroad retirement benefits within the meaning of “social security benefits” for this purpose. Per section 86, recipients of tier 1 railroad retirement benefits typically must include only 85% of the benefits received as gross income.