ORDERS:
FINAL ORDER AND DECISION
STATEMENT OF THE CASE
The above-captioned matter is before this tribunal pursuant to S.C. Code Ann. § 12-60-460
(Supp. 2003) upon Petitioner’s (Taxpayer) request for a contested case hearing to challenge
Respondent South Carolina Department of Revenue’s (Department) determination of the amount of
his military retirement excludable from his South Carolina gross income for tax years 1998 and
1999. In particular, Taxpayer contends that the entirety of his military retirement income should be
excluded from his South Carolina gross income for the tax years in question. He further argues that,
even if his entire military retirement income is not excludable, the Department has made several
miscalculations and misclassifications in determining that portion of his military retirement that is
excludable. The Department maintains that, under S.C. Code Ann. § 12-6-1120(7) (2000), only that
portion of Taxpayer’s military retirement income attributable to his service in the military
reserves–as opposed to that retirement income derived from his active duty service–is excludable
from his gross income The Department further contends that it correctly calculated the “exclusion
ratio” to be applied to Taxpayer’s military retirement to determine the proper proportion attributable
to his active and reserve duty.
After timely notice to the parties, a hearing of this case was held on March 30, 2004, at the
Administrative Law Judge Division in Columbia, South Carolina. Based upon the evidence and
arguments presented at that hearing, and upon the applicable law, I find that Taxpayer is not entitled
to exclude that portion of his military retirement income attributable to his active duty from his gross
South Carolina income under Section 12-6-1120(7) and that the Department’s adjustment of
Taxpayer’s income tax filings based upon the exclusion solely of Taxpayer’s reserve retirement
income 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.Taxpayer is a seventy-seven-year-old veteran of two wars and a long-time member
of the military reserves, who now receives military retirement income as a result of his military
service, both on active duty and in the reserves.
2.The military records submitted to the Department by Taxpayer, and admitted into
evidence at the hearing of this matter as Petitioner’s Exhibit #1, detail Taxpayer’s record of service
in the Armed Forces of the United States. According to those documents, Taxpayer served:
(1) on active duty at the end of the Second World War as a private in the United States
Marine Corps between February 12, 1945, and August 23, 1946, see Pet’r Ex. #1, “U.S. Marine
Corps Report of Separation”
;
(2) in the United States Air Force Reserve between June 9, 1948, and February 28, 1950,
reaching the rank of second lieutenant, see Pet’r Ex. #1, “Certification of Military Service”;
(3) on active duty in the United States Marine Corps during the Korean War between October
2, 1950, and April 2, 1952, attaining the rank of first lieutenant, see Pet’r Ex. #1, “Report of
Separation from the Armed Forces of the United States”; and,
(4) in the United States Marine Corps Reserves between April 1952 and November 12, 1979,
when he was placed on the Inactive Status List, thereby ending his active reserve status. See Pet’r
Ex. #1, “Reserve Retirement Credit Report.”
When Taxpayer was officially transferred to the Retired Reserve on January 1, 1985, Marine
Corps records indicated that Taxpayer had “completed 26 years, 7 months and 4 days of qualifying
Federal service” and would retire at the rank of colonel. See Resp’t Ex. #5, at e (Letter from P.X.
Kelley to Taxpayer of January 22, 1985). These records further indicated that Taxpayer would be
eligible to begin receiving his military retirement pay on his sixtieth birthday. Id.
3.On his 1998 and 1999 South Carolina income tax returns, Taxpayer deducted his
entire military retirement income from his gross income. However, before allowing these
deductions, the Department requested additional information from Taxpayer concerning the dates
of his active and reserve military service. After receiving this information, the Department
concluded that Taxpayer had 26 years and 7 months, or 319 months, of total service time in the
military, of which 34 months were active duty time (i.e., the 16 months of active duty between April
1945 and August 1946 plus the 18 months of active duty between October 1950 and April 1952).
Subtracting these 34 months of active duty from his total military service time of 319 months, the
Department determined that Taxpayer had 285 months of service time in the military reserves.
4.In order to ascertain what portion of Taxpayer’s retirement income was attributable
to his reserve service, and thus excludable from his South Carolina gross income under S.C. Code
Ann. § 12-6-1120(7) (2000), the Department calculated the ratio of the time Taxpayer served in the
reserves (285 months) to his total military service time (319 months). This calculation resulted in
an “exclusion ratio” of 89.3%, meaning that Taxpayer could deduct 89.3% of his military retirement
income from his gross income as retirement income attributable to service in the military reserves.
See Resp’t Ex. #6.
5.I find that the Department accurately and appropriately determined Taxpayer’s total
military service time, active duty service time, and reserve duty service time, and accurately and
appropriately calculated an exclusion ratio of 89.3% based upon those determinations.
6.On June 5, 2000, the Department issued Notices of Adjustment to Taxpayer reflecting
the application of this exclusion ratio to his military retirement income for tax years 1998 and 1999.
See Resp’t Ex. #9. As a result of those calculations, the Department determined that Taxpayer was
due a refund of $171.64 for tax year 1998 and $140.00 for tax year 1999. Taxpayer timely protested
these adjusted figures with the Department. In a Final Agency Determination dated August 29, 2003,
the Department affirmed that Taxpayer could only exclude retirement income attributable to his
reserve service from his gross income, but further concluded that the proper exclusion ratio to be
used in that calculation was 92.5%, resulting in an increased refund to Taxpayer of $247.12 for tax
year 1998 and $175.00 for tax year 1999. See Resp’t Ex. #11. However, this higher exclusion ratio
was derived based upon a misapplication of the final sentence of Section 12-6-1120(7).
Nevertheless, in this proceeding, the Department has accepted this error in favor of Taxpayer for tax
years 1998 and 1999, while maintaining that the proper exclusion ratio to be applied in subsequent
years is the original 89.3% figure.
7.Taxpayer timely requested a contested case hearing before this tribunal to challenge
the Final Agency Determination.
CONCLUSIONS OF LAW
Based upon the foregoing Findings of Fact, I conclude the following as a matter of law:
Pursuant to S.C. Code Ann. § 12-6-1120 (2000 & Supp. 2003), a taxpayer’s South Carolina
gross income is computed by making certain modifications to the taxpayer’s Federal gross income.
Among these modifications is that found in Section § 12-6-1120(7), which provides for a deduction
of certain military retirement benefits. See S.C. Code Ann. § 12-6-1120(7) (2000). That subsection
states:
South Carolina gross income does not include compensation or retirement benefits
received from the United States or any state for service in a state National Guard or
a reserve component of the Armed Forces of the United States. This exclusion only
applies to compensation and retirement benefits received for the customary annual
training period not to exceed fifteen days for guard members or fourteen days plus
travel time for reserve members, weekend drills, and inactive duty training. National
Guard or reserve members that are called to active duty are allowed to deduct fifteen
days of active duty pay if they have not excluded pay for the annual training period
for the same taxable year.
Id. The calculation of this exclusion is further elaborated upon in Regulation 117-87.63, which
provides:
That portion of pension or retirement income received by retired service personnel,
residents of this State, that can be attributed to time served in the National Guard or
Reserve components of the Armed Forces of the United States, is not taxable.
The non-taxable portion is determined by using a ratio of the time actually
served in the National Guard or Reserve to the total time spent in military service,
times total yearly pension or retirement.
27 S.C. Code Ann. Regs. 117-87.63 (1992).
Based upon these statutory and regulatory provisions,
the Department concluded that only the portion of Taxpayer’s military retirement income attributable
to his service in the armed forces reserves was excludable from his South Carolina gross income,
and calculated that excludable amount by applying the ratio of Taxpayer’s reserve service time to
his total military service time to his total yearly retirement income. Taxpayer, however, argues first
that his entire military retirement income should be excluded from his South Carolina gross income,
and second that, even if only his retirement income based upon his reserve service is excludable, the
Department has committed several errors in calculating the exclusion ratio to be used to determine
that excludable amount. Having fully considered the evidence presented and the applicable law, I
find that the Department has properly construed and applied the exclusion found in Section 12-6-1120(7) and Regulation 117-87.63 with regard to Taxpayer’s military retirement income, and that
Taxpayer’s arguments to the contrary must, therefore, fail.
As a preliminary matter, it must be noted that Taxpayer bears 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, Taxpayer has the burden of establishing that the Department misapplied the provisions
of Section 12-6-1120(7) and Regulation 117-87.63, read narrowly, in determining the amount of his
military retirement income excludable from his South Carolina gross income.
Taxpayer has not met this burden. First, it is abundantly clear from a plain reading of the
applicable statute and regulation that only that portion of Taxpayer’s military retirement income
attributable to his service in the United States Air Force and Marine Corps Reserves is excludable
from his South Carolina gross income. By its unambiguous language, Section 12-6-1120(7) provides
an exclusion from gross income of “compensation or retirement benefits received from the United
States or any state for service in a state National Guard or a reserve component of the Armed Forces
of the United States.” Id. (emphasis added). This section further clarifies that the exclusion “only
applies to compensation and retirement benefits received for the customary annual training period
. . . weekend drills, and inactive duty training,” i.e., the basic responsibilities of non-active-duty
service in the National Guard or armed forces reserves.
Id. Regulation 117-87.63 also clearly limits
this exclusion to retirement income from reserve duty, stating that “[t]hat portion of pension or
retirement income received by retired service personnel . . . that can be attributed to time served in
the National Guard or Reserve components of the Armed Forces of the United States, is not taxable.”
Id. (emphasis added). Under the plain language of the applicable law, Taxpayer is not entitled to
exclude his entire military retirement income from his South Carolina gross income; rather, he may
only exclude that portion of his retirement income attributable to his service in the armed forces
reserves. Stated inversely, under these provisions, the amount of Taxpayer’s retirement income
based upon his active-duty military service is taxable and must be included in his gross income.
Therefore, Taxpayer’s claim that he may deduct his entire military retirement income, including
benefits for both his active duty and reserve service, from his gross income cannot be sustained.
Second, the Department has accurately and appropriately calculated–at least in documents
other than the Final Agency Determination for tax years 1998 and 1999–the exclusion ratio to be
used to determine that portion of Taxpayer’s military retirement payments excludable from his gross
income. The procedure for calculating this exclusion ratio is set forth in Regulation 117-87.63,
which provides that “[t]he non-taxable portion [of military retirement benefits] is determined by
using a ratio of the time actually served in the National Guard or Reserve to the total time spent in
military service, times total yearly pension or retirement.” By dividing the amount of time served
by Taxpayer in the reserves by the amount of his total military service time, this calculation yields
the percentage of his military service represented by his service in the reserves, i.e., the “exclusion
ratio,” which is then applied to his total yearly military retirement benefits to arrive at the amount
of those benefits attributable to his reserve service.
In the case at hand, the Department calculated the exclusion ratio as provided in Regulation
117-87.63 based upon information contained in government documents provided to the Department
by Taxpayer. The Department determined Taxpayer’s “total time spent in military service” from a
letter from the Commandant of the Marine Corps to Taxpayer, in which it is noted that Taxpayer had
completed 26 years, 7 months, and 4 days, or approximately 319 months, of “qualifying Federal
service” at the time of his retirement. The use of “qualifying Federal service” to determine the
amount of Taxpayer’s military service is not only reasonable, cf., e.g., Wilson v. United States, 917
F.2d 529, 532 (Fed. Cir. 1990) (“Individuals who serve in these reserve components and who earn
a total of twenty or more years of qualifying federal service–combining the active duty years with
years of qualifying reserve time–are also eligible for a federal pension.”) (emphasis added), but also
in accordance with a long-standing, established policy of the Department. See, e.g., Ryder Truck
Lines, Inc. v. S.C. Tax Comm’n, 248 S.C. 148, 152-53, 149 S.E.2d 435, 437 (1966) (finding that
where an administrative construction of a statute has been applied for a number of years and has not
been addressed by the legislature, the presumption arises that the construction is approved by the
legislature). To determine the amount of time served by Taxpayer in the reserves, the Department
subtracted the 34 months of Taxpayer’s active duty service time, as derived from military documents
such as reports of separation and certificates of honorable discharge,
from his total qualifying
Federal service of 319 months, arriving at a figure of 285 months of reserve service time. Dividing
the 285 months of reserve time by Taxpayer’s 319 months of total military service, the Department
calculated an exclusion ratio of 89.3% to be applied to Taxpayer’s yearly military retirement income
to arrive at the amount excludable from his gross income. The data relied upon by the Department
in making these calculations are derived directly from official military records, and the methods used
by the Department in carrying out these calculations are those stated specifically in the relevant
statute and regulation. Accordingly, I find that an exclusion ratio of 89.3% is the proper ratio to be
applied to determine the amount of Taxpayer’s military retirement excludable from his South
Carolina gross income.
However, as noted above, the Department used an exclusion ratio of 92.5% in its Final
Agency Determination regarding Taxpayer’s income tax for tax years 1998 and 1999. This higher
exclusion ratio was derived based upon a misapplication of certain provisions of Section 12-6-1120(7). In the Final Agency Determination, the Department relied upon the same military
documents referenced above and arrived at the same total military service time and active duty
service time figures stated above.
The discrepancy with earlier calculations arises in the
Department’s attempt in the final determination to apply the last sentence of Section 12-6-1120(7),
regarding the 15-day deduction available to reservists and Guardsmen called to active duty, to
Taxpayer’s military service record. The Department first misapplies the sentence by “excluding”
15 days per year of annual training time from Taxpayer’s active duty service time and applying that
time to his reserve duty time. However, as that annual training time was already included the
calculation of Taxpayer’s time in the reserves, and was not included in the calculation of his active
duty time, this additional crediting of 15 days of reserve time per year results in a double exclusion
for Taxpayer’s annual reserve training time. The Department next misapplies the last sentence of
Section 12-6-1120(7) by applying the provision retroactively to Taxpayer’s service in the Korean
War. The deduction made available in that sentence was not enacted until 1995 and is not aimed at
providing retroactive credit for active duty service that occurred prior to its effective date, but at
providing a current-year deduction for Guardsmen and reservists called up to active duty. As such,
that provision is not applicable to Taxpayer’s Korean War service.
Therefore, while the Department
has agreed to abide by its error in favor of Taxpayer and retain the 92.5% exclusion ratio for tax
years 1998 and 1999, I find that the proper exclusion ratio to be applied to Taxpayer’s military
retirement income is the original 89.3% determination.
Further, I find that Taxpayer’s objections to the calculation of both the 89.3% and 92.5%
exclusion ratios are without merit. First, Taxpayer argues that the Department improperly calculated
his total military service time. While Taxpayer recognizes that the 319-month figure used by the
Department is one possible measure of his military service time, see Resp’t Ex. #7,
he further
contends that his military service time should be calculated to the present day because, once he was
commissioned in the military, he was in the military for life, and could, to this day, be called up for
active duty. Failing that, Taxpayer argues that his military service time should at least be calculated
day-for-day from his first enlistment in the military in 1948 to his official retirement from the
reserves in 1985. However, despite Taxpayer’s personal theories with regard to the nature of his
military status–theories which deem periods of retired and inactive status as periods of viable reserve
service–I find the Marine Corps’ accounting of Taxpayer’s qualifying Federal service at 319 months
to be the more reliable determination of his total time served in the armed forces. Second, Taxpayer
argues that his service during the Second World War has been reclassified by Federal statute as
“reserve time,” and should not be considered active duty time. However, the only particular statutes
referenced by Taxpayer to support his claim, 10 U.S.C. §§ 12732 and 12733, do not appear to
contain any provision reclassifying active duty, such as that served by Taxpayer during the Second
World War, as reserve duty.
And, nowhere in the military records submitted by Taxpayer is his
service during the final year of World War Two referenced as anything other than active duty
service. In short, Taxpayer’s challenges to the Department’s calculation of his total service time and
active duty service time must ultimately fail.
In conclusion, under the plain language of S.C. Code Ann. § 12-6-1120(7) (2000) and 27 S.C.
Code Ann. Regs. 117-87.63 (1992), Taxpayer is entitled to exclude from his South Carolina gross
income that portion of his military retirement income attributable to his service in the Air Force and
Marine Corps Reserves. However, as Taxpayer’s military retirement benefits also include
compensation for active duty service during the Second World War and the Korean War, and as such
benefits for active duty service are taxable, an exclusion ratio, as prescribed in Regulation 117-87.63,
must be calculated to determine what portion of his retirement is based solely upon his reserve duty,
and therefore, not taxable. Using information gleaned from the military records submitted by
Taxpayer, this exclusion ratio is properly calculated at 89.3%, thereby allowing Taxpayer to deduct
89.3% of his military retirement income from his gross income. For the tax years in question in this
matter, 1998 and 1999, the Department issued a Final Agency Determination that mistakenly allowed
Taxpayer to exclude a higher percentage of his military retirement income. But, as a matter of
fairness, the Department has decided to abide by this error in favor of Taxpayer for tax years 1998
and 1999. This tribunal will do so as well.
ORDER
Based upon the Findings of Fact and Conclusions of Law stated above,
IT IS HEREBY ORDERED that the Department’s Final Agency Determination of August
29, 2003, is SUSTAINED.
AND IT IS SO ORDERED.
______________________________
JOHN D. GEATHERS
Administrative Law Judge
Post Office Box 11667
Columbia, South Carolina 29211-1667
April 21, 2004
Columbia, South Carolina |
