Rev. Rul. 66-168

Federal Civil Service employees who resign sometimes withdraw amounts they have deposited in the United States Civil Service Retirement and Disability Fund (hereinafter referred to as the Fund). Should such an employee later re-enter Civil Service employment, he may elect to repay to the Fund the amount previously withdrawn. If he exercises this election, he is required, in addition, to pay a sum designated as "interest" on the redeposited amounts.

I.T. 3545, C.B. 1942-1, 49, holds that payments of the so-called "interest" described above are not deductible under section 23(b) of the Internal Revenue Code of 1939, predecessor of section 163 of the Internal Revenue Code of 1954, since they are not compensation for the use of borrowed money or for the forbearance of money legally due.

However, repaid deposits, and amounts paid as "interest", become a part of the employee's total retirement account. The total of these amounts combined with the employee's other deposits represent the consideration for his annuity. As part of the consideration for the annuity, the "interest" in question is excluded from the gross income of the annuitant in the manner and to the extent provided by section 72(b) or section 72(d) of the Code, whichever may be applicable.