Rev. Rul. 56-473

Advice has been requested concerning the treatment for Federal income tax purposes of amounts deducted from the salaries of public employees of the State of Arizona and credited to their retirement accounts pursuant to the employees' retirement system of that State.

The pertinent provisions of the Arizona state employees' retirement system act (sections 12-837-12-861, Arizona Code of 1939, as supplemented) provide for `open-end' annuities, conditional upon retirement, and in certain cases a pension based upon prior service and dependent upon retirement. The benefits are not measured by salaries nor length of service, except indirectly, but are dependent entirely upon the amount credited to the individual upon retirement. The account is made up of public funds equal to seven percent of the gross authorized salary for all public employment while a member of the retirement system. The seven percent credit is specified as a three and one-half percent `contribution' of the authorized salary by the member and an equal percent by the state. Under the act, the phrase `authorized salary' is used to emphasize the distinction between the gross pay from the amount remaining to the employee after crediting and deducting three and one-half percent contribution. The contributions by the members are held by a retirement board and become available to the employee only when the employee terminates his employment with the state and withdraws his contribution. When the employee applies for retirement benefits at or after age 60, he receives an annuity made up in part of his own contributions, the employer contributions, the excesses, if any, distributed from the contingency reserve fund and earnings on all of the funds in his account. He does not receive payment of his identifiable contribution.

Section 61(a) of the Internal Revenue Code of 1954 provides, in part, that gross income means all income from whatever source derived, including compensation for services.

It has been held that officers and employees in the civil service of the United States are required to report as taxable income the amount of compensation received by them for their services, plus the amount deducted for retirement pay. See Mim. 3995, C.B. XII-1, 25 (1933); T.D. 3112, C.B. 4, 76 (1921); and section 39.22(a)-2(b) of Regulations 118 applicable under the 1954 Code by virtue of Treasury Decision 6091, C.B. 1954-2, 47. Similarly, I.T. 3362, C.B. 1940-1, 18, holds that the amounts deducted from the salaries of municipal employees and paid into the municipal employees' annuity and benefit fund of the city of R , State of Illinois, pursuant to the Act of the General Assembly of the State of Illinois, were includible in the gross income of the employees for Federal income tax purposes.

In Malcolm D. Miller et al. v. Commissioner , 144 Fed.(2d) 287, affirming 2 T.C. 267, which supports the position taken in the above-cited rulings and regulations, it was held that deduction of the three and one-half percent of a Federal civil service employee's salary to purchase retirement benefits granted by the Civil Service Retirement Act, is the same as though the employee received his entire salary in cash and then sent a percentage thereof to the Civil Service Commission for the purchase of an annuity provided by law. The court in that case pointed out that a civil service employee accepts such employment subject to all the conditions and provisions of law relating to civil service employees, one of which is that he shall be deemed to consent and agree that three and one-half percent of his salary shall be deducted and used to purchase the retirement benefits granted by the Civil Service Retirement Act.

The reasoning employed in the Miller case seems equally applicable to the facts in the present case. Thus, when an individual accepts employment with the State of Arizona, he is subject to all of the conditions and provisions of law relating to the Arizona retirement system. As such, he impliedly consents to the withholding of a part of his compensation for the purpose of purchasing an annuity which, under the retirement system, becomes a vested right upon his retirement. Accordingly, it is held that the amounts deducted from the compensation of employees of the State of Arizona and credited to their retirement accounts constitute gross income within the meaning of section 61(a) of the Code and should be reported in their annual Federal income tax returns for the year in which deducted.