Rev. Rul. 54-138

Advice is requested whether a lump sum payment received during 1953 by a member of the Fleet Reserve attributable to increased retirement pay computed under the provisions of Public Law 720, Seventy-ninth Congress, 60 Stat. 993, approved August 10, 1946, constitutes back pay within the meaning of section 107(d) of the Internal Revenue Code.

Public Law 720, supra , amended the Naval Reserve Act of 1938, 52 Stat. 1175, by providing that an enlisted man of the Regular Navy who transferred to the Fleet Reserve after completing more than 16 years' total naval service and thereafter performed active duty which, when added to his prior service, equaled 20 or more years' naval service was, upon his subsequent release from active service, entitled to have his retainer or retired pay computed on the same basis as an enlisted man who originally transferred to the Fleet Reserve after completion of 20 or more years service. Inasmuch as Public Law 720, approved August 10, 1946, contained a retroactive feature, an enlisted man transferring to the Fleet Reserve became entitled to an increase in his retainer or retired pay computed from the day following his release to inactive service.

The manner in which this payment was to be computed was not finally determined until 1953 when a settlement agreement was reached on the basis of the decision of the United States Court of Claims in Christopher C. Sanders v. United States , 120 Ct.Cls. 501. Accordingly, such enlisted men did not receive the increase to which they were entitled under Public Law 720 until 1953, at which time they received a lump sum representing an adjustment in the retired pay dating from the day following their release to inactive service.

Section 107(d)(1) of the Code provides, in part, as follows:

IN GENERAL.-If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 per centum of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, * * *.

Section 107(d)(2) of the Code defines `back pay' for the purpose of the application of section 107(d)(1) of the Code as remuneration, including wages, salaries, retirement pay, and other similar compensation which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of certain specified events which events include `(ii) dispute as to the liability of the employer to pay such remuneration, which is determined after the commencement of court proceedings; * * *.'

Section 39.107-3 of Regulations 118 provides in part that back pay does not include additional compensation for past services where there was no prior agreement or legal obligation to pay such additional compensation. In the instant case there was no legal liability to make this payment until the approval of Public Law 720, supra .

In view of the foregoing it is held that that part of a lump sum payment received during 1953 by a member of the Fleet Reserve attributable to an increase in retired pay computed under the provisions of Public Law 720, supra , which represents payment for the period beginning with the day following such member's release to inactive service to August 10, 1946, does not constitute back pay within the meaning of section 107(d) of the Internal Revenue Code. The balance of the payment constitutes back pay, and the Federal income tax liability for the year in which received may be computed in accordance with the provisions of section 107(d)(1) of the Code, provided such amount exceeds 15 percent of the gross income for that year, which includes the entire amount of the lump sum payment received.