A tax case from the Fourth Circuit may have some far reaching effects in the area of pension division by Virginia courts in divorce cases. Waterman v. Commissioner, ___ F.3d ___, 14 VLW 18 (CA 4, 6/3/99).
Nationwide the courts have been calling it one way or the other on the interesting question of whether the attractive early-out deals offered by the budget-cutting Armed Services, in order to get highly-trained and highly-paid officers (such as pilots) to quit (because after all, who needs Armed Services in the peaceful world we have today?), should be classified as divorce-divisible pensions or not. Usually the highly abstract reasoning of the divorce courts turns upon whether these severance packages are compensation for past services or not. (The same debate that was entertained as to lump-sum severance pay for E.D. purposes in Luczkovich v. Luczkovich, 26 Va App 702, 496 SE2d 157 (1998).) In order to stick an early-retiring Navy officer with income tax liability on the $44,000 early-out package that the Navy told would him would be tax-exempt since he retired while on active duty in a combat zone, the IRS argued, and a majority of the Fourth Circuit agreed, that it is not compensation for past services, and thus not subject to any "combat-zone exception" to IRC §112. No, this bribe to leave the Navy early, the majority says, can't be considered compensation for prior services rendered, since it is strictly an enticement to leave the service. A very emphatic dissent by Judge King argues that §112 expressly authorizes exclusion of these payments from gross income, as does Treasury Regulation 1.112-1.