Army Veteran Seeking to Avoid Levy Loses Battle

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In the week in which we remember the veterans who have served our country, it seems an appropriate time to post a case involving intersection of service in the military and taxation of the financial benefits of military service.  For those more interested in this topic, there is a chapter entitled Assisting Military Clients in the ABA Tax Section publication “Effectively Representing Your Client before the IRS” and the chapter on military issues is available as a standalone section of the book. The 7th Edition of that book will be coming out with the next couple of months.

In a Collection Due Process (CDP) case a taxpayer can raise certain defenses and cannot raise certain other defenses. The case of Bruce v. Commissioner, T.C. Memo 2017-172 involves a veteran who seeks to stop the IRS from levying on his pension. In some ways it seems that the CDP issues concerning merits litigation gets caught up in a case that partially implicates the exemption from levy under 6334(a)(10). We have spilled a lot of ink discussing merits litigation in CDP cases but with the exception of a post on a bank levy which seemed to hit a Veteran Disability Payment we have spent little time talking about levy exemptions.

At the Legal Services Center of Harvard within which the Harvard Tax Clinic is located, there is also a veteran’s clinic. As a result of that and a grant we receive from a veteran’s organization enabling us to represent any veteran needing assistance, the Harvard Tax Clinic sees a fair number of veterans needing tax assistance. While most of the issues we see with veterans do not turn on some of the special tax provisions related to that group, some of the issues are impacted by special provisions for veterans. In the Bruce case, he seeks to cloak his income with the protective coating of a non-taxable disability military pension. He loses but the effort is worth a look.  There is a link between the non-taxable nature of a military pension and the exemption from levy.

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Mr. Bruce is a disabled Army veteran who retired on January 31, 2000 at the rank of chief warrant officer 3. The Department of the Army classified his retirement as regular but the “Department of Veterans Affairs subsequently assigned him an overall 80% disability rating retroactive to February 1, 2000 and individual unemployability resulting in a disability compensation at a 100% rate retroactive to December 19, 2002.”

Mr. Bruce argues that because of the retroactive determination, his retirement “should have been classified by the [Army] as a disability retirement.” He asked the Army to reclassify his retirement and it denied his request. He brought suit against the Army based on the denial and his case was dismissed. H appealed to the 11th Circuit which sustained the dismissal. He indicated to the Tax Court that he planned to go to the Supreme Court. Perhaps some of these actions have prevented him from focusing on his tax obligations and perhaps some of these actions made him take tax positions in anticipation of a different outcome.

Mr. Bruce alleged that the Army should have granted him a disability retirement rather than a regular retirement, citing as evidence the VA rating.  I am told that a veteran can seek to have his record corrected in order to switch from a regular retirement to a disability retirement through an application to the relevant Board for Correction of Military (or Naval) Records (which are the same Boards that handle some discharge upgrades). If the Board did grant him relief, it could potentially do so retroactively, I believe, which could affect tax liability.  It is unclear to me if his request to the Army to reclassify his retirement is the same type of request I describe in this paragraph.  If it is, perhaps his only path to having the retirement reclassified at this time is through a successful petition to the Supreme Court.

Because the Army did not reclassify his pension, it gets reported to the IRS as taxable. In 2011 he also received Social Security payments.  Based on the formula for taxing Social Security payments and his taxable pension payments, a fractional part of his Social Security payment amount was classified as taxable. In that year he received a gross distribution on his military pension of $28,822 which was entirely classified as taxable but he only had $20 of withhold. He did not file a 2011 return.

Back in 2011 the IRS would send taxpayers substitute returns when they did not file and the IRS has third party information indicating a taxable return. Of course, we know that today, Mr. Bruce might not receive anything from the IRS. As is typical in substitute for return cases, the IRS sent Mr. Bruce correspondence in which it calculated his 2011 liability based on the information available to it, waited for him to respond and when he did not it sent a notice of deficiency. Since he did not file a Tax Court petition, the IRS assessed the liability and began sending him collection notices culminating in the CDP notice giving him a right to talk to Appeals about the proposed levy action the IRS intended to take on the almost $6,000 he owed in taxes, penalties and interest for 2011.

Mr. Bruce, now alert to the imminent danger, timely filed a CDP request stating that he did not have the funds to pay the balance and that it was his position that the pension was not-taxable.  He argued that the non-taxable nature of the pension payments mooted the collection case by eliminating the basis for the assessment. In addition to 2011, he had many other unfiled returns which Appeals sought before it wanted to talk to him about his levy problem. Appeals also told him a merits discussion was off the table because he had the chance to go to Tax Court regarding his 2011 liability when the IRS sent the notice of deficiency and he chose not avail himself of that opportunity. Eventually, Appeals issued a notice of determination denying Mr. Bruce relief from the levy.  He timely filed a Tax Court petition and the IRS filed a motion for summary judgment.

The Court goes through a pretty standard analysis of his failure to petition the Tax Court upon receipt of the notice of deficiency and how that precludes Mr. Bruce from challenging the merits of his tax liability at this time. I totally agree with the analysis and the outcome denying him a merits determination in his CDP case.

I was left wondering, however, about how his pension fits into levy side of the equation. I wondered what would have happened if Mr. Bruce had raised IRC 6334(a)(10) as a defense to levy against his pension during the CDP case. If he had done so it should not have changed the outcome of the case which would have allowed the IRS to levy because a CDP case is not an exemption from levy case. Even if his pension is exempt from levy, the IRS could still propose levy action, which is not a proposal against specific funds or income streams, and the Court would have, on these facts, sustained the determination. It is still possible, however, that depending on the nature of his pension it might restrict the funds upon which the IRS can levy. Does the taxable nature of the pension as it stands today waiting for his Supreme Court challenge automatically mean that the pension does not qualify for the levy exemption?

In order to resolve my questions about Mr. Bruce’s pension on the levy, I consulted with someone more expert than me and received the following advice about his situation as it interplays with military pensions.

In Mr. Bruce’s situation, the pension would not be exempt from levy under 6334(a)(10) because his pension results from his time of service in the military and not his disability and this will never change no matter what happens at the Veteran’s Administration. The situation is not, however, entirely straightforward and this is probably what has confused Mr. Bruce. To achieve the result that he seeks he needed to have gone through a disability review by the Army before he retired or seek a retroactive review from the Army separate and apart from the review received from the VA. Because the review was done by the VA after retirement, he falls into a different scheme and his “regular” military pension remains taxable and subject to levy for the rest of his life. He does, however, receive other benefits that are not taxable and that are exempt from levy.

If a service member receives disability payments from the VA, his “regular” military retirement pay is reduced by the amount of his VA disability compensation (referred to as an “offset”). This happens if the service member’s disability rating falls between 10% and 49%. This offset portion of the ‘regular” pension would not be taxed under those circumstances but the other portion would still be taxed and still be subject to levy.

If a retired service member receives a “regular” pension from Defense Finance Accounting Service (DFAS) as well as disability pay from the VA at a disability rating of 50% or higher, the disability payment is added to his military retirement pay. This is called “Concurrent Retirement and Disability Pay (CRDP). This CRDP is exempt from levy under 6334(d)(10).

Examples:

Retired service member “A” receives monthly retirement pension of $1,000, and has no disability rating. The entire $1,000 is taxable.

Retired service member “B” receives monthly retirement pension of $1,000, but has a disability rating of 30%. His disability compensation through the VA is $100. The DFAS pays him $1,000, but only $900 of it is taxable; $100 is not taxable.

Retired service member “C” receives monthly retirement pension of $1,000, but has a disability rating of 75%.  His disability compensation through the VA is $100.  The DFAS pays him $1,000, and the VA pays him $100.  He receives $1,100, of which $100 is not taxable.

From the available information it would appear that Mr. Bruce receives CRDP because his disability rating greater than 50%.

It also appears that Mr. Bruce would receive the Individual Unemployability benefit, which allows the VA to pay certain veterans at the 100-percent disability rate even though their service-connected disabilities are not rated as 100-percent disabling. Veterans may be eligible for this rating increase if they are either unemployed or unable to maintain substantially gainful employment as a result of their service-connected disability. It is meant to compensate veterans unable to work because of service-connected disability or disabilities that do not meet the VA rating requirements for a total evaluation at the 100-percent rate.

Conclusion

So, Mr. Bruce’s regular military pension is now in the IRS crosshairs. The IRS may take 15 percent of it through the Federal Payment Levy Program as discussed in a recent post and it may take 15 percent of his Social Security pension.   Because his income level causes the IRS filters to stay away from the Social Security payments but those filters do not apply to his military pension even if he is low income, in his situation the IRS may only take from his “regular” military pension but not his Social Security Pension.

The CRDP payments and the Individual Unemployability benefit increase the funds available to veterans in a way that makes them a little different from Social Security recipients and other persons for whom the IRS has applied income filters. The complexity of military benefits may be what caused the IRS not to make an initial decision to apply its filters to these payments.  I have waded into deep water on the military pension issues and others more expert than me may be posting comments that will shed further light on this situation.

 

 

Comments

  1. complicated issue. thank you for your column. i appreciate the educational experience.

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