UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA
March 5, 1985
JAKE LAPIN, Plaintiff,
UNITED STATES OF AMERICA, Defendant
Oliver Gasch, United States District Judge.
The opinion of the court was delivered by: GASCH
This is an action for a refund of federal income taxes paid for the taxable years 1975 and 1977 through 1980. Plaintiff has moved for summary judgment only as to his claim for a tax refund from the year 1975 for the amount of state taxes he paid on a federal cost of living allowance that he contends was exempt from federal income tax.
For the reasons set forth below, plaintiff's motion is denied, and judgment is entered for the United States of America.
In 1975 plaintiff was a civilian employee of the United States Government in Honolulu, Hawaii. In addition to his salary, plaintiff received in 1975 a cost of living allowance ("COLA") in the amount of $ 3,898.40. A cost of living allowance is paid to employees of the United States government whose basic salary is fixed by statute and who are stationed in Hawaii or certain other areas outside the continental United States. The allowance is given for living costs that are substantially higher than in the District of Columbia. See S. Rep. No. 627, 78th Cong., 1st Sess., 24 (1944); C.B. 1944, 973 at 992; Rev. Rul. 59-407, 1959-2 C.B. 19-21.
Although such COLA is exempt from federal income tax, it is taxable by the State of Hawaii. Accordingly, plaintiff paid Hawaii income taxes on the $ 3,898.40 COLA for the taxable year 1975. Plaintiff then claimed a deduction on his 1975 federal income tax return for the amount of Hawaii state taxes he paid on the COLA. In April 1979, plaintiff received a notice of deficiency in the amount of $ 1,335.00 plus interest on his 1975 federal tax return. The Internal Revenue Service determined that $ 203 of that deficiency represented the amount of state income tax plaintiff paid on the COLA which plaintiff deducted on his federal return and which the IRS disallowed pursuant to I.R.C. § 265 and Rev. Rul. 74-140.
Plaintiff contends that he is entitled to a deduction on his 1975 federal income taxes for the amount of income tax he paid to the State of Hawaii on the COLA. He relies on I.R.C. § 164, which generally allows a deduction for state income taxes paid. Alternatively, plaintiff argues that because of its noncompensatory character, the COLA is not "income" and thus not within a class of income wholly exempt from tax within the meaning of I.R.C. § 265(1), which bars deductions for amounts allocable to a class of income wholly exempt from federal gross income. Plaintiff's arguments are without merit.
Section 265(1) of the Internal Revenue Code disallows deductions on income that is not subject to federal income tax. The section provides:
No deduction shall be allowed for --
(1) Expenses - Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this subtitle, or any amount otherwise allowable under Section 212 (relating to expenses for production of income) which is allocable to interest (whether or not any amount of such interest is received or accrued) wholly exempt from the taxes imposed by this subtitle.
It is well settled that Section 265(1) takes precedence over I.R.C. § 164, which authorizes deductions on federal income taxes for state income taxes paid. Section 161 expressly provides that deductions specified in Part VI of Subchapter B of Subtitle A of the Internal Revenue Service Code of 1954, which includes Section 164, is "subject to the exceptions provided in Part IX," which includes Section 265(1). See also Commissioner v. Idaho Power Company, 418 U.S. 1, 17, 41 L. Ed. 2d 535, 94 S. Ct. 2757 (1974). Accordingly, plaintiff is not entitled to deduct from his federal income the amount of Hawaii state taxes that he paid on the 1975 COLA.
Plaintiff contends, however, that the COLA is not income within the meaning of Section 265(1) because it is noncompensatory in character. Plaintiff relies principally on a Senate report concerning the exemption from federal income tax of certain COLAs granted to federal employees.
There is nothing in the report, however, that even suggests that COLAs are not considered income. Under the Internal Revenue Code, gross income means all income from whatever source derived, unless excluded by law. Treas. Reg. 1.61. The COLA at issue in this case is a class of income excluded by I.R.C. § 912 from gross income.
Plaintiff's reliance on Manocchio v. Commissioner, 710 F.2d 1400 (9th Cir. 1983), is misplaced. In that case, the court held that an airline pilot could not deduct from his federal income tax flight training expenses for which he was reimbursed by the Veterans Administration because reimbursed expenses are not deductible under I.R.C. § 162(a). Significantly, Manocchio concerned a direct reimbursement, not a flat living stipend as the COLA in this case. Furthermore, in view of its reliance on Section 162(a), the court in Manocchio expressly declined to reach the question of whether the deduction was disallowed under I.R.C. § 265(1) as the Tax Court had found. The Tax Court reasoned that the reimbursement received by the airline pilot qualified as a class of income exempt from gross income and thus I.R.C. § 265 disallowed any deduction for such exempt income. 78 T.C. 989 (1982). Similarly, the COLA at issue in this case is a class of income exempt from gross income and Section 265(1) bars plaintiff from taking any deduction for the COLA, including a deduction for the amount of state taxes paid on the COLA.
There being no material issues of fact in dispute, the Court denies plaintiff's motion for summary judgment. Plaintiff is not entitled to deduct from his 1975 federal income tax the amount of State of Hawaii income taxes paid by plaintiff on the COLA.
Upon consideration of plaintiff's motion for summary judgment on the sole question of whether plaintiff is entitled to a deduction on his 1975 federal income tax return for state taxes paid on a cost of living allowance, the opposition of defendant thereto, and it appearing to the Court that there are no material issues of fact in dispute, and for the reasons stated in the memorandum accompanying this order, it is by the Court this 2nd day of March, 1985,
ORDERED that plaintiff's motion for summary judgment be, and hereby is, denied; and it is further
ORDERED that judgment be, and hereby is, entered for the defendant, the United States of America as to plaintiff's claim regarding plaintiff's deduction for taxable year 1975 of state income tax paid on a cost of living allowance.