IRC Section 104 provides that compensation for injuries and sickness are not taxable and are excluded from income. In Bakken v. Commissioner, TCS 2011-55, the court concluded that the disability income of a police officer who was injured in the line of duty and became permanently disabled remained nontaxable under Section 104 when he reached the eligible retirement age under the plan.
Officer Bakken served on the police force for 18 years and was injured in the line of duty, becoming permanently disabled and unable to perform the duties of a police officer. The Austin Policemen’s Benefit Association approved his application for a disability pension as a result of his injuries. He was not qualified for retirement due to his age at the time the benefit was granted by the Association. He was given the same benefit as someone that would have retired at the regular retirement age. Once the officer reached retirement age the Association converted the payments to a pension payment and issued Bakken a 1099-R showing the payments as taxable.
The Tax Court held that since Bakken had completed less than 20 years of service when he attained age 50, he remained ineligible for retirement. Thus, the character of the payments remained unchanged, and he was entitled to exclude his pension distribution from income.