Ralph F. Waterman v. Commissioner of Internal Revenue

179 F.3d 123, 23 Employee Benefits Cas. (BNA) 1280, 83 A.F.T.R.2d (RIA) 2687, 1999 U.S. App. LEXIS 11264, 1999 WL 357185

• Court: Court of Appeals for the Fourth Circuit
• Decided: June 3, 1999
• Docket: 98-2053
• Status: Published

Opinions

Affirmed by published opinion. Judge LEE wrote the majority opinion, in which Chief Judge WILKINSON joined. Judge KING wrote a dissenting opinion.

OPINION

LEE, District Judge:

Ralph F. Waterman (“Waterman”) appeals from the United States Tax Court’s decision that there is a deficiency in income tax due for the taxable year 1992 in the amount of $7,536.00 for a $44,946.49 special separation benefit he received as a result of his acceptance of an early separation offer from the Navy. The issue is whether the Tax Court correctly held that a $44,946 payment made to a taxpayer by the Navy pursuant to an early separation agreement is not excludable from income under I.R.C. § 112(a) as “compensation received for active service in a combat zone.” Finding no reversible error, we affirm.

I.

Waterman served in the Navy as an enlisted member for fourteen years and three months. From January 1 through May 4, 1992, Waterman was stationed aboard the U.S.S. America in the Persian Gulf, which was a designated combat zone at that time. On April 20,1992, Waterman accepted an early separation from service offer, which included a special separation payment (“separation payment”) made by the Navy as part of its downsizing program under 10 U.S.C. § 1174a. By accepting the Navy’s offer, Waterman agreed to leave the Navy and to give up any pension benefits that would have been available to him after he had completed 20 years of service.

In May 1992, Waterman left the U.S.S. America and the Persian Gulf, and he received an honorable discharge from the Navy. The Navy paid Waterman a separation benefit of $44,946.49, the calculation of which was based in part on the length of Waterman’s service. At that time, the Navy advised Waterman that he was not required to include the separation payment in his gross income.¹ The Navy did withhold $9,158.69, primarily for federal income taxes. Waterman requested a refund of the withheld taxes and the Navy issued him a check representing the federal income tax withheld. Waterman did not file an income tax return for the 1992 tax year.

The Commissioner of Internal Revenue (“Commissioner”) determined that the separation payment constituted taxable income and issued Waterman a notice of deficiency on February 27, 1995, determining a tax deficiency of $10,038. The Commissioner also determined that Waterman was liable for additions to tax. Waterman filed a petition in United States Tax Court (“Tax Court”) in May 1995, and an amended petition in July 1995, seeking a redeter-mination of the deficiency. Waterman contended that the separation payment was excludable from his income under I.R.C. § 112. The parties fully stipulated the facts in the case and there was no trial held. During the proceedings in Tax Court, the Commissioner conceded the additions to tax and also conceded that because Waterman’s separation payment was calculated based upon his time of service in the Navy, the portion of his service spent in a designated combat zone was excluda-ble from his gross income.

The Tax Court considered a “matter of first impression involving whether an early separation payment, the right to which arose and became fixed while a member of the military was serving in a combat zone, is excludable from gross income under section 112.” The Tax Court reviewed the statutory language in I.R.C. § 112(a)(1), which is often called the “combat zone exception” because it excludes compensation for active service in a combat zone from taxable gross income. Due to the lack of legislative history, the Tax Court considered regulations touching upon the meaning of compensation in that statute. In deciding whether a separation payment is compensation received for active service in a combat zone, the Tax Court noted that the statutory language concerning when and how the compensation must be earned is not ambiguous. The Tax Court interpreted the regulations to mean that the time and place of payment are irrelevant when considering whether compensation is excludable under § 112.

The Tax Court held that the separation payment was in exchange for Waterman’s agreement to leave the military. Although measured by length of service, the Tax Court noted, the payment was not for prior service, in a combat zone or otherwise. Because the payment was in exchange for the agreement to leave the Navy early, the payment did not qualify as compensation received for active service under the statute. Thus, Waterman was required to include the separation payment in his gross income for 1992. The portion of the payment based on service spent in a designated combat zone was not included in the gross income calculation because the Commissioner conceded that the portion was excludable. The Tax Court noted that under its interpretation of the statute, no such portion should be excluded, but it did not require payment of taxes on that portion due to the Commissioner’s concession that the portion was excludable.²

Thus, the Tax Court determined that Waterman was deficient in paying income tax on the special separation benefit. This appeal followed.

II.

We review decisions of the United States Tax Court on the same basis as decisions in civil bench trials in United States district courts. Ripley v. Commissioner of Internal Revenue, 103 F.3d 332, 334 n. 3(4th Cir.1996); Estate of Waters v. Commissioner of Internal Revenue, 48 F.3d 838, 841-42 (4th Cir.1995). Questions of law, such as whether the separation payment was excludable from Waterman’s income, are reviewed under the de novo standard and findings of fact are reviewed for clear error. Ripley, 103 F.3d at 334 n. 3; Estate of Waters, 48 F.3d at 842. The Tax Court’s interpretation of statutory language is also reviewed under the de novo standard. Estate of Waters, 48 F.3d at 842.

III.

Waterman’s primary argument is that because he became entitled to the separation payment while he was on active service in a combat zone, he was entitled to exclude it from his gross income under 1.R.C. § 112(a)(1). Waterman points to Treasury Regulation § 1.112~l(b)(4), which provides that the time and place of the entitlement to compensation determine whether the compensation is excludable under section 112. Waterman also claims that the Navy made a similar conclusion when it initially withheld taxes from the payment, but subsequently refunded the withholding upon Waterman’s request under the § 112 combat zone exception. Waterman contends that a separation payment should be treated no differently than other types of compensation that are ex-cludable under section 112, such as dislocation allowances, reenlistment bonuses, pay for accrued leave, compensation for employment in clubs and messes, and awards for suggestions, inventions, or scientific achievements.

The core issue here is whether a separation payment for an agreement to leave service early in lieu of retirement which accrues while the service member is on active duty in a combat zone constitutes compensation for active service such that it is excluded from gross income under § 112(a). The Court holds that this separation payment does not fall within the § 112(a) definition of “compensation received for active service.”

Section 112(a) of the Internal Revenue Code provides in pertinent part:

(a) Enlisted personnel

Gross income does not include compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States for any month during any part of which such member—

(1) served in a combat zone....

I.R.C. § 112(a)(1) (1988). Treasury Regulation § 1.112-l(b)(4) provides in relevant part:

[T]he time and place of the entitlement to compensation determine whether the compensation is excludable under section 112. Thus, compensation can be excluded under section 112 whether or not it is received outside a combat zone ... provided that the member’s entitlement to the compensation fully accrued in a month during which the member served in the combat zone.... For this purpose, entitlement to compensation fully accrues upon the completion of all actions required of the member to receive the compensation.

Judicial review of an agency regulation that construes a statute entails a two-step process. First, we must determine whether the statute directly addresses the precise issue before us. “If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Snowa v. Commissioner of Internal Revenue, 123 F.3d 190, 195 (4th Cir.1997) (quoting Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984)). Second, if the statute is silent or ambiguous in expressing congressional intent, we must determine whether the agency’s interpretation is based on a permissible construction of the statute. Snowa, 123 F.3d at 195. We give great deference to the Commissioner’s interpretation and uphold any Treasury Regulation that implements the statutory purpose in a reasonable manner. See Rowan Cos. v. United States, 452 U.S. 247, 252, 101 S.Ct. 2288, 68 L.Ed.2d 814 (1981).

The Court holds that the statutory language in § 112 is clear and unambiguous. Section 112(a) excludes from the calculation of income tax any “compensation received for active service ... in a combat zone.” The Court finds no error in the Tax Court’s finding that Waterman’s separation payment did not constitute compensation for active service in a combat zone. Waterman’s separation payment was not made for his service in the Persian Gulf. Rather, the Navy paid Waterman a separation payment in exchange for his agreement to leave Navy service early and fore-go any right to pension benefits.

The Court holds that the time and place of acceptance of the separation payment are irrelevant to this determination. On this point, Treasury Regulation § 1.112-1(b)(4) is helpful. It contains an example involving a reenlistment bonus, stating that it can be excluded from income as combat zone compensation although it was received outside the combat zone. The exclusion was not based on where the enlisted member was when he received the payment. Instead, the member was entitled to the exclusion because he became entitled to the reenlistment bonus during a month in which he served in the combat zone.

Waterman argues that under that example, he should be entitled to the combat zone exclusion because he accepted the separation payment while serving in the combat zone. Thus, his entitlement to the separation payment “fully accrued” during a month in which he actively served in a combat zone. We disagree.

The entitlement argument is inapposite because the time and place of the entitlement are irrelevant to the determination of an exclusion in this case. The Treasury Regulation example may be distinguished from this case because the reenlistment bonus falls under the definition of “compensation received for active service.” The member who reenlisted will serve again, perhaps in a combat zone. Waterman’s separation payment was not compensation for active service. It was a payment to entice Waterman to leave service. Thus, whether Waterman was in a combat zone when he accepted the Navy’s offer of a separation payment is irrelevant. Section 112(a) does not premise the exclusion solely on the location of the enlisted personnel. Rather, the exclusion is based on whether the compensation is for active service and whether that service is in a combat zone.

Because the separation payment was not compensation for Waterman’s service but an inducement to leave Navy service, the Court holds that Waterman was not entitled to the exclusion for combat zone service. The Commissioner stipulated that a portion of Waterman’s separation payment was excludable based on the amount of time Waterman did serve in a combat zone.³ Despite its lack of agreement with that conclusion, the Tax Court decided not to disturb the exclusion of that portion of the separation payment due to the stipulation. We will not disturb the Tax Court’s decision on that issue.

The dissent gives short shrift to the issue of whether a separation payment constitutes compensation under section 112. According to the dissent, because the separation payment is neither a pension nor a retirement payment, which are both excluded by section 112(c)(4), it must be compensation. Under this interpretation, any payment for any act while in a combat zone would be excludable. Such a reading was not intended and is not permissible because the language of the statute is plain. Section 112(c)(2) clearly states “compensation received for active service” not acceptance of a separation payment. The separation payment was not “compensation” or payment for active service, as the dissent concedes must be proven, rather it was a “severance deal, a deal which the government had actively sought as part of its post-war downsizing program.” Dissent, at 133. Treasury Regulation 1.112-l(b)(4), which the dissent cites, supports the conclusion that the exclusion applies to compensation for services rendered, not to payments like the separation benefit. That regulation provides, “Compensation received by a member of the Armed Forces for services rendered while in active service can be excluded under section 112.... ” (Emphasis added.) Waterman did not receive the separation payment as compensation for services rendered while in active service. He received the separation payment in exchange for his agreement to leave active service and fore-go any future right to pension benefits. Nonetheless, Waterman did receive an exclusion for the compensation he did receive for services rendered while in active service. The Commissioner stipulated to such an exclusion and despite the Tax Court’s disagreement with that conclusion, the exclusion was upheld.

IV.

Finding no clear error, we affirm the Tax Court’s decision that there was a deficiency in income tax due from Waterman for the separation payment he received during the taxable year 1992.

AFFIRMED.

1 . The dissent argues that the government "shamelessly double-crossed Mr. Waterman” by inducing him to accept the separation offer based on a purported tax benefit. There is no evidence in the record to support a finding of any such inducement. Indeed, the evidence is to the contrary. During the proceedings before the Tax Court, the parties stipulated to the following: “Upon acceptance of the Navy’s early separation offer, the petitioner was advised by the Navy that payments received pursuant to his early separation would be excludable from gross income if accepted while serving in a designated combat zone." (J.A. at 6). The Tax Court accepted this stipulation by placing it in the decision. (J.A. at 19). Thus, Waterman had already accepted the separation offer when he learned of the supposed tax benefit. Furthermore, Waterman's counsel admitted at oral argument that the IRS is not bound by a statement by the Navy about the excludability of the separation benefit. Waterman’s counsel also stated that he was not arguing that the IRS is estopped by the Navy’s posture on this issue.

2 , Whether a stipulation entered into by par-lies to a tax case should be set aside is a matter within the sound discretion of the tax court, which we review for an abuse of discretion. Balkissoon v. Commissioner of Internal Revenue, 995 F.2d 525 (4th Cir.1993). Presumably because the Tax Court did not set aside the stipulation, neither party has argued this issue and the Court declines to address it.

3 . The dissent argues that the fact that the separation payment was calculated based on the length of Waterman’s active service supports the conclusion that the separation payment was for active service. Dissent at 129-30. That position is untenable not only because the manner of calculation does not determine whether the payment constitutes compensation, but also because the separation payment was not measured solely by the length of Waterman's active service. Rather, the Tax Court found that the amount of the "separation payment was, in part, measured by petitioner's 14 years and 3 months of active military service.” (J.A. at 19).