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Non-taxable service-connected disability pension benefits

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Guest PA consultant

If a local government employee's service-connected disability pension benefit is deemed to be non-taxable (ie. considered in the nature of workers' compensation), is it non-taxable for life?

The answer to this question in the Governmental Plans Answer Book (Q 11:43) basically says that it is only non-taxable until retirement eligibility. But in parentheses afterward it says that the tax treatment of disability payments subsequently changed and that this statement is not useful in describing current tax treatment of disability. I can't find anything about the current tax treatment of disability pensions in the 2005 Cumulative Supplement.

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See Rev Rul 2004-55 for a current treatment of this issue.

Generally, if disability is provided under an employee benefit plan, and is funded by after-tax employee contributions, then any disability benefits received under the plan are excludable from gross income. However, if the plan is funded with pre-tax contributions, then disability benefits are includible in gross income.

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Guest PA consultant

That Ruling deals with compensation from a disability insurance policy, not workers' compensation or disability pension benefits paid "in the nature of workers' compensation." So I don't think that answers my question, unless I'm missing the connection.

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You might look for guidance from IRS Pub 575 on income from pensions and annuities.

The relevant guidance I found is below:

"Disability Pensions

If you retired on disability, you generally must include in

income any disability pension you receive under a plan that

is paid for by your employer. You must report your taxable

disability payments as wages on line 7 of Form 1040 or

Form 1040A until you reach minimum retirement age.

Minimum retirement age generally is the age at which you

can first receive a pension or annuity if you are not dis-


You may be entitled to a tax credit if you were from railroad retirement benefits.

permanently and totally disabled when you re-

tired. For information on this credit, see Publication 524.

Beginning on the day after you reach minimum retire-

ment age, payments you receive are taxable as a pension

or annuity. Report the payments on Form 1040, lines 16a

and 16b or on Form 1040A, lines 12a and 12b.

Disability payments for injuries incurred as a direct result of a terrorist attack

directed against the

the United States United States (or its allies), are not included in

income. For more information about payments to survivors

on your benefits, of terrorist attacks, see Publication 3920, Tax Relief for

Victims of Terrorist Attacks."

Are you researching this to administer the plan and issue the 1099r forms?

If so, then get a more validated legal opinion than this forum provides.

For example, you should determine if the employee contributions constitute

a payment by the employee in after-tax dollars for disability coverage. If so,

you could reasonably interpret that the disability payments are tax free.

If not, you must accept the taxation ruling of the 1099r issuer as presumptive proof

of the taxation. I know 1099 can be issued incorrectly, but the burden of proof is

on the taxpayer to correct it.

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Since this is a govermental entity, was there a "pick up" of the employee contribution? I can give some on point cites but I could not get to them now.

In general if it qualifies as tax free initially it will stay with that status for life as long as the purpose of the payments stay as is for life.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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I think that the answer is found in IRC section 104(a)(1), which provides as follows:

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include—

(1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness * * *.

Kirk Maldonado

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  • 2 weeks later...
Guest PA consultant

The reference you quoted from Pub. 525 relates to disability pension in general, not to the exemption for amounts paid "in the nature of workers' compensation." The service related disability benefits in my client's plan are payable for life, or until recovery from the disability (which typically doesn't happen since to qualify, it must be expected that the disability will be permanent). Previously, it was my understanding that, barring a "conversion to normal retirement benefit at normal retirement date" clause, the benefit would remain non-taxable for life. However, as I said in the original post, the answer to this question in the Government Plans Answer Book made me question that understanding. The employer asked us the question so they can properly instruct the administrator who pays the retiree checks and prepares the 1099-R forms.

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Sorry I can't help here, because I don't know the legal basis for a disability pension that is in the form of workman's compensation. I would have to ask the attorneys who set it up and local experts on workmans comp for the state where this plan resides.

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