ORDERS:
FINAL ORDER AND DECISION
STATEMENT OF THE CASE
This matter is before me pursuant to Petitioners’ (Taxpayers) request for a contested case
hearing under S.C. Code Ann. § 12-60-470(F) (2000). In this case, Taxpayers, a married couple,
seek a refund from Respondent South Carolina Department of Revenue (Department) of income taxes
paid on disability benefits received by Taxpayer Husband during the 1999, 2000, and 2001 tax years.
Taxpayers claim that they are entitled to deduct the disability benefits from their taxable South
Carolina income for the tax years in question under S.C. Code Ann. § 12-6-1140(4) (2000), as
“amounts . . . received for disability retirement due to permanent and total disability.” While the
Department concedes that Taxpayer Husband is permanently and totally disabled, it further contends
that the amounts received by Taxpayer Husband cannot be deducted from Taxpayers’ taxable income
under Section 12-6-1140(4) because those amounts were paid as long-term disability insurance
benefits to a current employee, not as disability retirement payments to a retired individual.
After timely notice to the parties, a hearing of this case was held at the Administrative Law
Judge Division in Columbia, South Carolina, on October 30, 2003. Based upon the evidence
presented and arguments made at that hearing, and upon the applicable law, I find that Taxpayers are
not entitled to the deductions they claim under Section 12-6-1140(4) and that the Department’s
denial of Taxpayers’ claim for a refund based upon those deductions must be sustained.
FINDINGS OF FACT
Having carefully considered all testimony, exhibits, and arguments presented at the hearing
of this case, and taking into account the credibility and accuracy of the evidence, I make the following
Findings of Fact by a preponderance of the evidence:
1.During the 1999, 2000, and 2001 tax years, Taxpayer Husband received disability
insurance benefits under Merrill Lynch & Company’s (Merrill Lynch) Basic Long-Term Disability
(LTD) Plan. Merrill Lynch, Taxpayer Husband’s employer, paid these benefits to Taxpayer as a
result of a total and permanent disability that prevented him from continuing to work at Merrill
Lynch.
2.Merrill Lynch’s Basic LTD Plan pays disabled employees “60% of [their] eligible
compensation up to $60,000, for a maximum annual benefit of $36,000.” See Pet’r Ex. #5, at 2. For
the tax years in question, Taxpayer Husband received $22,236 per year as disability benefits under
the plan.
3.Merrill Lynch paid the premiums on Taxpayer’s LTD policy and did not include those
contributions in Taxpayer’s gross income. See Pet’r Ex. #5, at 4 (“Cost of Coverage”).
4.The disability benefits in question were paid to Taxpayer Husband by Metropolitan,
the administrator of Merrill Lynch’s Basic LTD Plan. Metropolitan classified the disability benefits
as wages on Taxpayer’s 1999, 2000, and 2001 W-2 Forms.
See Resp’t Ex. #3, 6, 8.
5.Under Merrill Lynch’s LTD Plan, benefits continue to be paid, subject to certain time
limits, until the beneficiary recovers, fails to provide proof of continuing disability, is no longer under
the continuous care of a doctor, exhausts certain mental health/substance abuse benefits, retires, dies,
or becomes eligible for long-term disability benefits under a non-Merrill Lynch group disability plan.
See Pet’r Ex. #5, at 10 (“When Benefits End”) (emphasis added). Accordingly, upon his retirement
from Merrill Lynch, Taxpayer Husband no longer received disability payments under the LTD plan,
but instead began receiving pension payments under his Merrill Lynch retirement plan.
6.As noted above, the disability payments received by Taxpayer Husband during the tax
years in question were paid under Merrill Lynch’s Long-Term Disability Plan, not under its
Retirement Program. Merrill Lynch’s Retirement Program does not contain a disability retirement
provision, see Resp’t Ex. #14; instead, Merrill Lynch offers its employees benefits under the LTD
Plan to serve as a wage substitute during times of disability, including permanent and total disability.
7.During the time he was receiving long-term disability payments from Merrill Lynch,
Taxpayer Husband was still considered an employee of Merrill Lynch and Merrill Lynch continued
to make contributions to his retirement account. See Resp’t Ex. #14, at 20 (“If You Become
Disabled”).
8.Taxpayers did not initially deduct Taxpayer Husband’s disability payments from their
taxable income on their 1999 and 2000 South Carolina income tax returns. However, in April 2002,
Taxpayers filed amended income tax returns for 1999 and 2000 with those disability payments
deducted from their taxable income and filed a 2001 South Carolina income tax return with the
disability benefits deducted from their income.
9.The Department initially granted Taxpayers a refund of $1553 for tax year 1999 based
upon their amended return. However, upon further review, the Department determined that
Taxpayers were not entitled to deduct Taxpayer Husband’s disability benefits from their taxable
income. Therefore, on October 7, 2002, the Department issued a proposed assessment disallowing
the deductions taken for the disability payments on the amended 1999 return, amended 2000 return,
and original 2001 return and seeking payment of the $1553 refunded to Taxpayers under the amended
1999 return and the $1415 Taxpayers underpaid for 2001 because of the deduction. The
Department’s assessment also included interest on the 1999 refund and both a penalty and interest
on the 2001 underpayment.
10.Taxpayers paid the taxes, interest, and penalties assessed by the Department and
submitted a claim for a refund. In this refund claim, Taxpayers seek the amounts paid under the
Department’s assessment and the disallowed refund under the amended 2000 return, for a total refund
of approximately $5125. The Department denied Taxpayers’ claim for a refund, and Taxpayers
timely filed an appeal of the denial with the Department.
11.In a Final Agency Determination dated August 12, 2003, the Department again found
that Taxpayer Husband’s disability benefits could not be deducted from Taxpayers’ income and
denied Taxpayers’ claim for a refund of the taxes paid on those benefits. Taxpayers timely requested
a contested case hearing before this tribunal to challenge the Department’s denial of their refund
claim.
CONCLUSIONS OF LAW
Based upon the forgoing Findings of Fact, I conclude the following as a matter of law:
The sole question at issue in this matter is whether the long-term disability benefits received
by Taxpayer Husband constitute “amounts . . . received for disability retirement due to permanent and
total disability” that may be deducted from Taxpayers’ South Carolina taxable income under S.C.
Code Ann. § 12-6-1140(4) (2000).
The parties agree that Taxpayer is permanently and totally
disabled so as to satisfy the disability requirements of the section. Their disagreement is over the
meaning of the term “disability retirement.” Taxpayers read the term in a general sense and argue
that, because Taxpayer Husband’s disability prevented him from ever returning to work at Merrill
Lynch, he was essentially “retired” by his disability such that his disability payments should be
considered “amounts received for disability retirement.” The Department, however, construes the
term “disability retirement” in a much stricter sense, finding that only those benefits paid under a
disability provision of a retirement plan, to a technically “retired” individual, may be deducted from
income under Section 12-6-1140(4). Based upon the evidence presented and the applicable law, I
find that the Department’s construction of Section 12-6-1140(4) is correct and that its denial of
Taxpayers’ claim for a refund must, therefore, be sustained.
As a preliminary matter, it must be noted that Taxpayers bear the burden of proof in this case.
“Where a tax officer has disallowed a deduction, the ruling of such officer is presumed to be correct
and the taxpayer has the burden of proving it to be wrong.” 85 C.J.S. Taxation § 1773, at 786
(2001); cf. Cloyd v. Mabry, 295 S.C. 86, 88, 367 S.E.2d 171, 173 (Ct. App. 1988) (“A taxpayer
contesting an assessment has the burden of showing that the valuation of the taxing authority is
incorrect.”). Further, it is well-settled under South Carolina law that “a deduction is not a matter of
right but is one of legislative grace” and that “[t]o obtain a deduction, the taxpayer must bring himself
squarely within the terms of the statute expressly authorizing the deduction.” Allied Corp. v. S.C.
Tax Comm’n, 288 S.C. 197, 199, 341 S.E.2d 139, 140-41 (1986); see also S. Soya Corp. of
Cameron v. Wasson, 252 S.C. 484, 488, 167 S.E.2d 311, 313 (1969) (same); S. Weaving Co. v.
Query, 206 S.C. 307, 313-14, 34 S.E.2d 51, 54 (1945) (same). Moreover, beyond the allocation of
burden of proof, principles of statutory construction require statutes allowing deductions from
taxation, if ambiguous, to be construed strictly against the taxpayer. C.W. Matthews Contracting Co
v. S.C. Tax Comm’n, 267 S.C. 548, 557, 230 S.E.2d 223, 227 (1976); see also, e.g., S. Soya Corp.,
252 S.C. at 489, 167 S.E.2d at 313 (“The rule generally applicable in the construction of income tax
statutes that ambiguities are to be resolved in favor of the taxpayer . . . does not apply in the
construction of a statute authorizing deductions; rather, the ambiguity will be resolved against the
taxpayer.”) (quoting 47 C.J.S. Internal Revenue § 230) (omission in original). Therefore, in the case
at hand, Taxpayers have the burden of establishing that the disability benefits received by Taxpayer
Husband fall squarely within a narrow construction of the “disability retirement” deduction in Section
12-6-1140(4).
Taxpayers have not met their burden. They argue that disability benefits received by an
individual who is permanently unable to return to work constitute “disability retirement” payments,
even if those benefits are not paid under a retirement plan and the recipient is not technically retired.
However, “disability retirement” simply cannot be read as broadly as Taxpayers would like. Under
a strict construction of Section 12-6-1140(4), the term “retirement” cannot be ignored or reduced
to a general notion of failing to return to work. Rather, “retirement” must be understood as just
that–formal retirement from employment. Consequently, “disability retirement” must be construed
as those benefits paid, under a retirement plan, to an individual who has been officially retired because
of a disability. It cannot be stretched to include any sort disability benefits paid to an employee who
may not work again because of his disability. See York County Fair Ass’n v. S.C. Tax Comm’n, 249
S.C. 337, 341, 154 S.E.2d 361, 363 (1967) (holding that statutory exemptions from taxation “will
not be strained or liberally construed in favor of the taxpayer claiming the exemption”).
This construction of the term “disability retirement” accords with how the term is used
elsewhere in South Carolina law. The statutes governing the various retirement programs
administered and regulated by the state all contain a “disability retirement” provision that places such
benefits squarely under the respective retirement program and that requires the beneficiary of those
disability retirement payments to be formally retired by the relevant authority before collecting the
benefits. See S.C. Code Ann. § 9-1-1540 et seq. (1986 & Supp. 2002) (South Carolina Retirement
System), S.C. Code Ann. § 9-8-60(3) (Supp. 2002) (Retirement System for Judges and Solicitors),
S.C. Code Ann. § 9-9-65 et seq. (1986) (Retirement System for Members of the South Carolina
General Assembly), S.C. Code Ann. § 9-11-80 et seq. (1986 & Supp. 2002) (South Carolina Police
Officers’ Retirement System), and S.C. Code Ann. § 9-13-160 et seq. (1986) (Firemen’s Pension
Funds in Cities). In short, under its general usage in the South Carolina code, “disability retirement”
refers to payments made from a retirement plan to an individual who has been officially retired
because of a disability.
In the case at hand, it is clear that the benefits received by Taxpayer Husband were not such
“disability retirement” benefits. The benefits were not paid under a retirement plan. The disability
payments received by Taxpayer Husband were paid under Merrill-Lynch’s long-term disability
insurance plan, not under its retirement program, and were reported as wages, not as retirement
benefits. Further, the benefits were not paid to an officially retired individual. At the time he received
the disability benefits, Taxpayer Husband was not considered retired by Merrill Lynch. Just as with
other active employees, Merrill Lynch continued to make contributions to Taxpayer Husband’s
retirement account during the period he was receiving long-term disability benefits, and, as required
by the LTD plan itself, Merrill Lynch discontinued Taxpayer’s disability benefits upon his actual
retirement. Therefore, as the disability benefits received by Taxpayer Husband were neither paid from
a retirement program, nor paid to a retired individual, those payments cannot be considered “amounts
. . . received for disability retirement” to be deducted from Taxpayers’ taxable income under Section
12-6-1140(4).
In sum, under a strict, but plain, reading of Section 12-6-1140(4), only those disability benefits
paid under a retirement plan to a retired individual constitute “disability retirement” payments that
may be deducted from a taxpayer’s taxable South Carolina income. Here, while the benefits received
by Taxpayer Husband were disability benefits, those benefits were not paid as retirement benefits to
a retired individual. Rather, the benefits were paid as long-term disability insurance payments to a
current employee. As such, those amounts were not deductible from Taxpayers’ taxable income
under Section 12-6-1140(4). I find, therefore, that the Department properly disallowed Taxpayers’
claim for such deductions for tax years 1999, 2000, and 2001, and properly denied Taxpayers’
request for a refund based upon those claimed deductions.
ORDER
Based upon the Findings of Fact and Conclusions of Law stated above,
IT IS HEREBY ORDERED that the Department’s denial of Taxpayers’ claim for a refund
of taxes paid on disability insurance benefits received in 1999, 2000, and 2001, is SUSTAINED.
AND IT IS SO ORDERED.
______________________________
JOHN D. GEATHERS
Administrative Law Judge
December 15, 2003
Columbia, South Carolina |
