UFOA: IRS Set To Tax Part Of Disability Payout
By REUVEN BLAU

The Internal Revenue Service has issued a preliminary ruling that the disability pension for civil servants injured on the job will no longer be completely tax-free, according to the union representing fire officers.

JOHN J. McDONNELL: 'News is not good.'

"We're just waiting for a final decision," said John J. McDonnell, president of the Uniformed Fire Officers Association, during a Jan. 22 phone interview.

IRS 'Prevailed'

According to the UFOA, the IRS "prevailed" and the extra benefits that will be taxable in January 2009 include the increased take-home pay (ITHP) and the 1/60th supplement. That latter benefit applies to retirees who served beyond the minimum retirement age and who now are receiving pensions that are based on an added 1.67 percent of salary for each year they worked past the basic service requirement.

"The city has an agreement with the IRS to pay $44,000 so that they will not have to adjust all disability retirees' past pension payments," the UFOA Web site added.

The Law Department, however, maintained that there was no preliminary agreement with the IRS and that the matter was still being "negotiated." The IRS declined to comment, citing its longstanding policy of not responding to personal tax questions.

'Bad News'

But Mr. McDonnell said "the news was not good." The IRS's official ruling, he added, was initially expected to be issued by the end of December.

The issue arose after a question about the retirement fund's tax-free status was raised by a retired Teacher last year.

The potential problem, which could reduce payouts to thousands of injured retirees living on fixed incomes, appears to primarily affect three supplemental aspects of the benefit that some receive in conjunction with the disability pension.

"The significance would be someone that retired six or 10 years ago and bases their retirement lifestyle on what they were told they were going to receive, now they have to be concerned that they overextended themselves financially," Mr. McDonnell said.

The central component of the pension - payments worth 75 percent of a worker's final average salary - will likely remain tax-free, said city and union officials familiar with the situation.

IRS Law Details

By all accounts, only five or 10 percent of the benefit will likely be taxable, depending on various factors. But any added costs could create a significant burden for disabled retirees.

After the issue surfaced, union officials pointed out that initial reviews conducted by tax attorneys indicated that some of those parts of the pension would likely be taxable.

According to the IRS law, any payment in the nature of Workers' Comp could be tax-free. But an IRS 2006 tax booklet also states: "The rest of your pension, based on years of service, is taxable as pension or annuity income."

Since its conception more than a half-century ago, the benefit, known as a three-quarter disability pension, has been completely exempt from city, state, and Federal taxes.

A conference call took place between the city and union attorneys, who reached out to IRS representatives last July. But the parties declined to discuss details of that preliminary conversation and other subsequent discussions, noting that the issue is still being reviewed.

Retro Obligations?

The disability pension, which covers practically all the city's more-than 300,000 employees, has been touted as a tax-free benefit for more than 70 years.

It remains unclear if any of the possible tax obligations will be retroactive, but the IRS can only go back three years, according to regulations.

"The city has to be concerned with how they are going to go forward," Mr. McDonnell said. "It would have to be an administrative nightmare to re-send 1099s to every disability retiree in every single city agency in the last three years, and that's something that they were trying to avoid."

It is also uncertain whether the IRS's decision will have national ramifications. One uniformed labor leader said that he researched the issue and discovered that there are various practices concerning similar public-employee pensions throughout the nation.

"We are very anxiously awaiting the final decision. Needless to say, there are hundreds of retirees that this could affect," Mr. McDonnell said.