Rev. Rul. 81-192

ISSUES

1. Are contributions made by employers and employees to the New York nonoccupational disability benefit fund under the New York Disability Benefits Law deductible under section 164(a) of the Internal Revenue Code?

2. Are contributions made by employers and employees to private plans for the payment of nonoccupational disability benefits under the New York Disability Benefits Law deductible under section 164(a) of the Code?

FACTS

Reconsideration has been given to Rev. Rul. 71-73, 1971-1 C.B. 52, and a portion of Rev. Rul. 72-191, 1972-1 C.B. 45, relating to the deductibility of contributions made by employers and employees to the New York nonoccupational disability benefit fund pursuant to the New York Disability Benefits Law. New York Workmen's Compensation Law, sections 200 through 242 (McKinney 1965 and Supp. 1980). Also reconsidered under the same provisions of New York law is the deductibility of contributions made by employers and employees to private plans for payment of nonoccupational disability benefits.

Rev. Rul. 71-73 holds that contributions made by employees pursuant to the New York Disability Benefits Law are not ordinary and necessary business expenses within the meaning of section 162(a) of the Code. Rev. Rul. 71-73 also holds that such contributions are personal expenses of the employees and are not deductible for federal income tax purposes.

Rev. Rul. 72-191 holds that contributions by the employer to the New York nonoccupational disability benefit fund are contributions to an accident or health plan, and as such are ordinary and necessary business expenses deductible by the employer under section 162 of the Code.

The New York statute provides weekly disability benefits based upon average weekly wages to eligible individuals, who are totally disabled and unable to perform any work for remuneration as a result of suffering an accident or sickness not compensable under the workmen's compensation law. In addition, unemployed individuals who are eligible for state unemployment benefits but who become totally disabled and, thus, unable to obtain unemployment benefits are eligible for a weekly disability benefit. The purpose of this New York law is to protect against the hazard of earnings loss caused by nonoccupational sickness or accident.

Both employers and employees may be required to make contributions to the state fund providing disability benefits. With respect to any employee contributions to the state disability benefits fund, an employer is required to withhold the amount of such contributions from the employee's wages at the time the wages are paid.

As an alternative to the state fund providing disability benefits, state law provides an option whereby any employer may establish a private plan for the payment of disability benefits. The benefits under such a private plan may be provided through an insurance contract issued by an authorized private insurer or through a plan of self-insurance. Benefits under a private plan must be at least equal to the disability benefits provided by the state fund. The cost of the private plan may be paid solely by either the employer or the employee or may be paid jointly by the employer and employee. However, an employee cannot be required to contribute toward a private plan an amount that is greater than that required to be paid to the state disability benefits fund except by agreement and provided the contribution is reasonably related to the value of the benefits as determined by the chairperson of the workmen's compensation board of the State of New York. Neither the employer nor the employee is required to contribute to the state disability benefits fund if the employer establishes such a private plan.

LAW AND ANALYSIS

Section 164(a)(3) of the Code specifically provides for the deduction of state income taxes. In addition to the taxes specifically enumerated in section 164(a), that section provides for the deduction of state taxes that are paid or accrued within the taxable year in carrying on a trade or business.

Section 162(a) of the Code allows as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 262 of the Code provides, that, except as otherwise expressly provided, no deduction shall be allowed for personal, living, or family expenses.

Principles developed under federal law, not state interpretations or designations, determine whether a payment falls within the meaning of the terms "taxes" and "income taxes" as used in federal statutes. See Rev. Rul. 79-180, 1979-1 C.B. 95; Rev. Rul. 76-215, 1976-1 C.B. 194; Rev. Rul. 71-49, 1971-1 C.B. 103; and Rev. Rul. 61-152, 1961-2 C.B. 42.

The word "taxes" has been defined as an enforced contribution, exacted pursuant to legislative authority in the exercise of the taxing power, and imposed and collected for the purpose of raising revenue to be used for public or governmental purposes and not as a payment for some privilege granted or service rendered. See Rev. Rul. 77-29, 1977-1 C.B. 44; Rev. Rul. 71-49; Rev. Rul. 61-152; and Rev. Rul. 58-141, 1958-1 C.B. 101. Further, it is the position of the Service that a tax must be paid to a government levying the tax, to certain public benefit corporations created by that government for a public purpose, or to their agents. See Rev. Rul. 74-525, 1974-2 C.B. 411; Rev. Rul. 74-58, 1974-1 C.B. 180; and Rev. Rul. 71-49.

Employer and employee contributions to the New York disability benefit fund meet the above standards and concept of "taxes" because such contributions are exacted pursuant to legislative authority in the exercise of the taxing power of the state, and are imposed and collected by the state for the purpose of raising revenue to be used for a governmental function that serves public purposes.

Amounts paid or accrued by employers to the New York disability benefit fund being state "excise taxes" do not qualify as any of the types of taxes enumerated in section 164(a) of the Code. See Rev. Rul. 81-191, page 49, this Bulletin. However, such amounts are state taxes paid or accrued by the employers in carrying on a trade or business and, therefore, are deductible by the employers under section 164(a).

Amounts withheld from the wages of employees for contribution to the New York disability benefit fund qualify as state "income taxes" under section 164(a)(3) of the Code. See Rev. Rul. 81-191, and Trujillo v. Commissioner, 68 T.C. 670 (1977). However, such amounts are deductible by an employee only if the employee's deductions are itemized in computing taxable income under section 63(b).

Employer and employee contributions to private plans for the payment of disability benefits are not "taxes" within the meaning of section 164(a) of the Code. Such contributions are not paid to a government levying the tax, to certain public benefit corporations created by that government for a public purpose, or to their agents. Such contributions are also not taxes because the contributions do not have to be measured by, or equal, the amount of contributions imposed on employees and employers by the regular taxing statutes for the state disability benefit fund. Also, the specific amount of contributions to a private disability plan is neither fixed in amount nor imposed on the employer or its employees by a specific state statute. There is no maximum amount that an employer must contribute to a private plan. Further, the employer may assume all or part of the cost of the plan. Compare Rev. Rul. 71-49.

Although contributions to private plans for payment of disability benefits are not "taxes" within the meaning of section 164(a), such contributions paid or incurred in carrying on a trade or business are deductible by the employers under section 162(a) as ordinary and necessary business expenses.

It is the longstanding position of the Internal Revenue Service that contributions made by employees to private plans for the payment of disability benefits under New York law are neither taxes deductible under section 164 of the Code nor ordinary and necessary business expenses deductible under section 162, but are nondeductible personal expenses under section 262. See Rev. Rul. 71-73; I.T. 3967, 1949-2 C.B. 33, superseded by Rev. Rul. 75-149, 1975-1 C.B. 64; I.T. 3970, 1949-2 C.B. 28, superseded by Rev. Rul. 75-48, 1975-1 C.B. 62. Although an employee is in the trade or business of being an employee, this fact does not convert all amounts withheld from wages, whether mandatory or nonmandatory, into deductible trade or business expenses under section 162 of the Code. The nature of the withheld expenditure in terms of the benefit purchased or obtained determines whether such expenditure is a deductible business expense. Amounts paid by employees to fund private plans for the payment of disability benefits are not paid or accrued in carrying on a trade or business because they are incurred to provide indemnity coverage for loss of wages due to unemployment resulting from nonoccupational hazards rather than from business hazards. The nonoccupational personal nature of the benefit aspect of the private disability plans makes the contributions to the private plans nondeductible personal expenses under section 262.

Furthermore, amounts contributed to private plans for payment of disability benefits which are attributable to coverage providing indemnity for loss of earnings during disability are not deductible as medical expenses under section 213 of the Code. See Rev. Rul. 68-212, 1968-1 C.B. 91 which holds that premiums paid for insurance policies providing indemnity for loss of earnings during disability will not be deductible as medical expenses under section 213 for taxable years beginning after December 31, 1966.

HOLDINGS

1. Contributions made by employers to the New York nonoccupational disability benefit fund are state taxes paid or accrued in carrying on a trade or business and, therefore, are deductible by the employers under section 164(a) of the Code.

Amounts withheld from the wages of employees for contribution to the New York nonoccupational disability benefit fund qualify as state "income taxes" and, therefore, are deductible by the employees under section 164(a)(3) of the Code. However, such amounts are deductible by an employee only if the employee's deductions are itemized in computing taxable income under section 63(b).

2. Contributions made by an employer to private plans for the payment of nonoccupational disability benefits are not "taxes" within the meaning of section 164(a) of the Code. However, such contributions paid or incurred in carrying on a trade or business are deductible by the employers under section 162(a) as ordinary and necessary business expenses.

Contributions made by employees to private plans for the payment of nonoccupational disability benefits are not "taxes" within the meaning of section 164(a) of the Code, and are not ordinary and necessary business expenses within the meaning of section 162(a). In addition, no portion of such contributions are deductible as medical expenses under section 213. Thus, such contributions are nondeductible personal expenses under section 262.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 71-73 is superseded. Rev. Rul. 72-191 is modified.