Rail Carrier Was Not Required to Withhold Taxes on Payments of Stock to Employees

(Parker Tax Publishing August 2017)

The Eighth Circuit reversed a district court and held that a rail carrier was not required to withhold taxes on payments of stock to its employees or on ratification payments to union member employees. The court found that the payments were not compensation subject to taxes because the stock payments were not money remuneration and the ratification payments were not payments for services rendered by employees. Union Pacific Railroad Company v. U.S., 2017 PTC 350 (8th Cir. 2017).

The Union Pacific Railroad (UP) paid about $75 million in taxes from 1991 to 2007 under the Railroad Retirement Tax Act (RRTA). As a railroad, UP and its employees are not subject to Federal Insurance Contribution Act (FICA) taxes. Instead, they pay tax on benefits provided under the Railroad Retirement Act (RRA). During the years at issue, UP paid its employees in company stock in addition to a monetary salary and paid RRTA taxes on the stock payments. UP also paid RRTA taxes on payments it made to employees when their unions ratified collective bargaining agreements. The payments were intended to encourage unions to ratify collective bargaining agreements. The recipient had to be employed by UP on a certain date and the amount of the payment was determined by the number of hours the employee worked the previous year.

UP sued the IRS in a district court for a refund of the RRTA taxes it paid on the stock payments and the ratification payments, arguing that the RRTA did not require it to pay taxes on these payments. A district court rejected the UP's refund requests and granted summary judgment in favor of the IRS. UP appealed to the Eighth Circuit.

Under Code Sec. 3231(e)(1), the RRTA tax is based on an employee's compensation, which is generally defined as any form of money remuneration paid to an individual for services rendered as an employee. In Reg. Sec. 31.3231(e)-1(a)(1), the IRS has interpreted the statute by adopting the broad FICA definition of compensation in Code Sec. 3121, which includes stock payments.

UP challenged the IRS's broad interpretation of the term "compensation" in the regulation. It focused on the term "money remuneration" in Code Sec. 3231 and argued that the term "money" means a medium of exchange, which does not include stock. The IRS asserted that the term "money" is ambiguous, and that it is either superfluous or has an expansive meaning relating to capital or finance in general. It also noted that Code Sec. 3231 contains various exemptions for noncash payments and argued that these exemptions implied a broad definition of money remuneration. The IRS further argued that stock is the functional equivalent of cash, and finally that its interpretation in the regulation should stand because the purposes of FICA and RRTA are similar.

The Eighth Circuit reversed the district court's decision on both the stock payments and the ratification payments. With respect to the stock payments, the Eighth Circuit declined to defer to the IRS's interpretation of the statute in the regulation. It held that the stock payments were not compensation subject to RRTA taxes because they were not money remuneration. As to the ratification payments, the court held that they were not compensation for purposes of the RRTA because they were not paid for services rendered as employees.

The court began by addressing the meaning of "money" under Code Sec. 3231(e)(1). The court was not convinced that the IRS's expansive definition of money reflected the ordinary, common meaning of the term. According to the court, money refers to a generally accepted medium of exchange which does not include stock. The court found support for this view in a case decided near the time the RRTA was enacted, where an appeals court held that the ordinary meaning of money did not include corporate stocks. The IRS's broad definition of money, in the court's view, also conflicted with a regulation adopted shortly after the passage of the RRTA which defined compensation as "all remuneration in money, or in something which may be used in lieu of money (scrip and merchandise orders, for example)." The court reasoned that there would be no need to include scrip or merchandise orders as examples if, as the IRS asserted, money meant either nothing or all property. To the court, these examples made sense only if the more restrictive meaning of money applied.

Next, the court noted the significance of Congress's use of the term "compensation" in the RRTA statue and "wages" in the FICA statute, reasoning that differences in statutory language convey differences in meaning. The court found that the distinction between these terms is reinforced by the definition of "successor employers" in the RRTA statute. The RRTA statute adopts the FICA definition but uses "compensation" (as defined in the RRTA) where the FICA statute says "remuneration." The court inferred that Congress used these different terms because compensation, which includes only money remuneration, is a subset of remuneration, which Congress used in defining "wages" in the FICA statute. The court reasoned that it would make no sense to swap these terms if compensation had the same meaning as remuneration and wages.

The Eighth Circuit also rejected the IRS's argument that the noncash exemptions from compensation in Code Sec. 3231(e)(1) imply a broader definition of money remuneration. The court determined that none of the exemptions identified by the IRS would be rendered superfluous under UP's reading of the statute because each could include payments consistent with an interpretation of money as a medium of exchange. The exemptions in fact arguably indicated a narrower definition of money, according to the court. For example, where the RRTA statute exempts cash tips under $20, the FICA statute excludes "tips paid in any medium other than cash" as well as cash tips under $20. That Congress did not exclude noncash tips in the RRTA statute suggested to the court that they were already excluded under the general definition of "compensation." Finally, the fact that the noncash exemptions were codified years after the enactment of the general definition of compensation did not amount to an implied repeal in the court's view. The court found no indication that Congress intended to alter the original scope of money remuneration to something beyond a medium of exchange.

The Eighth Circuit was not persuaded by the IRS's argument that stock is the practical equivalent of cash. The court reasoned that even a stock with a readily ascertainable share price is not money because it is not a medium of exchange; like any property, stock has a cash value and can be exchanged for money, but that does not make it a generally accepted medium of exchange. Nor did the court agree that the RRTA statute should be interpreted to reach as far as the FICA statute because the statutes share a similar purpose. In the court's view, such a vague notion of statutory purpose could not override the actual text of the statute.

Regarding in the ratification payments, the court held that the payments were not compensation because they were not for services rendered. The court found that UP did not exercise control over whether a union ratifies a collective bargaining agreement. Further, although the ratification payments were made from UP's payroll, which generally raises a presumption that the payments are compensation, the court found that UP used its payroll department only because the union's members worked for several companies and UP had to determine which members were UP employees.

For a discussion of the taxes imposed under FICA and RRTA, see Parker Tax ¶213,135 and ¶213,160, respectively.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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