INSIGHT: The Meaning of ‘Money’ Under the Railroad Retirement Tax Act and Why It Matters Beyond the Railroads

In Wisconsin Central Ltd. v. United States, 138 S. Ct. 2067 (2018), the U.S. Supreme Court shed light on the meaning of “money” in the Railroad Retirement Tax Act of 1937 (RRTA) a mere 81 years after its enactment. The Wisconsin Central decision, holding that stock does not count as “money” for purposes of the RRTA, may be a harbinger of increasing scrutiny of regulations by a textualist court with little patience for Chevron deference. Certainly, railroad employers are presented with an obvious tax planning opportunity but all taxpayers may view this as an opening to consider whether even interpretations that are long settled should be reviewed in light of a more restrictive view of “money” and other words on the page that are susceptible to a different meaning if one finds the right dictionary.

Wisconsin Central v. United States

Wisconsin Central Ltd. (Wisconsin Central) is one of a number of railroads that determined in recent years to test whether stock-based compensation is “money” as that word is used in the definition of “compensation” subject to the RRTA. Beginning in 1996, the railroad began compensating some employees with nonqualified stock options for shares in the railroad’s publicly held parent. In 2014, the company filed suit, seeking $13 million in tax refunds for RRTA taxes paid on options exercised between 2006 and 2013. The railroad asserted that RRTA taxes had been overpaid because the income generated by exercise of the options was not “compensation” subject to the RRTA. As Wisconsin Central’s action wound its way up from the district court to the circuit court to the Supreme Court, a number of other railroads litigated similar actions. By the time the Supreme Court granted certiorari to hear the case, several circuit courts had ruled on the question. The U.S. Courts of Appeals for the Fifth and Seventh Circuits ruled for the Internal Revenue Service, but the Eighth Circuit ruled for the railroads, creating a split. (See BNSF Ry Co. v. United States, 775 F.3d 743 (5th Cir. 2015); Wisconsin Central Ltd. v. United States, 856 F.3d 490 (7th Cir. 2017); Union Pac. R.R. v. United States, 865 F.3d 1045 (8th Cir. 2017).)

The Railroad Retirement Act

In a manner similar to the Federal Insurance Contributions Act (FICA), the RRTA taxes railroad employers and employees on amounts the employees earn in order to fund retirement and disability benefits for those employees and their families. The two regimes fund similar retirement programs established during the Great Depression by the Social Security Act of 1935 and the Railroad Retirement Act of 1937. Unlike the Social Security system, the Railroad Retirement Act (RRA) system federalized an existing program under which benefits were already promised to railroad employees. (See Kevin Whitman, “An Overview of the Railroad Retirement Program,” 68 Soc. Sec. Bull. 41 (2008).) The Social Security system would provide benefits to a much larger population of employees for work performed in 1937 and thereafter. The RRA provides certain benefits that are not available to Social Security beneficiaries, including a second tier of benefits (Tier 2 Benefits) intended to function like a defined benefit pension plan, an occupation disability benefit available to employees who are disabled from their regular occupation but are not totally disabled, and an unreduced benefit at an earlier age for certain employees.

The Railroad Retirement Tax Act

Congress has repeatedly amended the FICA regime and the RRTA regime in parallel. The two systems do have certain differences, but these have eroded over time. The RRTA Tier 1 tax functions like FICA, imposing a 6.2 percent tax on compensation up to an annually adjusted wage base ($128,400 in 2018). Unlike FICA, the RRTA also imposes a Tier 2 tax at a rate that fluctuates based on Railroad Retirement Board (RRB) assets up to a separate annually adjusted wage base.

Whereas FICA taxes “wages,” the RRTA taxes “compensation.” Although defining similar concepts, the statutory definitions are not identical. FICA defines “wages” as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” (tax code Section 3121(a).) The RRTA defines “compensation” as “any form of money remuneration paid to an individual for services rendered as an employee to one or more employers.” (Section 3231(e)(1).) Both definitions are subject to a number of exceptions. Notably, one of these exceptions—added by the American Jobs Creation Act of 2004, Pub. L. 108-357—excludes income arising from the exercise of an incentive stock option. (Section 3231(e)(12)(A).)

The original Treasury regulations under the newly enacted RRTA defined compensation as “all remuneration in money, or in something which may be used in lieu of money (scrip and merchandise orders, for example).” (2 Fed. Reg. 2198, 2202 (Oct. 15, 1937).) The term, “money remuneration” does not appear elsewhere in the Internal Revenue Code. However, the term does appear in the RRA. Like the RRTA, the RRA defines compensation as “money remuneration.” (45 U.S.C. Section 231(h)(1).) The RRA “compensation” definition drives the calculation of average monthly compensation used to determine Tier 2 Benefits owed to a particular railroad employee.

Because the term “money remuneration” also appears in the RRA, the RRB separately grappled with the meaning of the term. On April 22, 1938, the RRB issued an opinion responding to a question of whether shares of common stock paid to employees in exchange for a reduced rate of pay were “compensation” to be taken into account for purposes of determining average monthly compensation. (Railroad Retirement Bd. Gen. Counsel Memorandum No. L-38-440.) The RRB opined that the stock was not compensation but premised this conclusion on the circumstances under which the particular stock was paid and not on the fact that the stock could not be “money remuneration.” In fact, the RRB took the opportunity to set forth a standard for when stock would constitute money remuneration, advising, “[h]owever, if such stock was received by such employees as a part of their agreed compensation for services actually rendered and at a definite agreed value, such value may be included in the computation of the average monthly compensation.” Importantly, this approach tracks the current regulatory treatment of in-kind benefits by the RRB. (20 C.F.R. Section 211.2(a) (treating such benefits as compensation if the employer and employee agree on “[t]he value of the commodity, service, or privilege; and [t]hat the amount agreed upon to be paid may be paid in the form of the commodity, service or privilege”).)

In 1994, Treasury and the IRS amended the RRTA regulations to expressly define RRTA “compensation” to have “the same meaning as the term wages” under FICA, a change that one commenter challenged as unwarranted because the statutory language is not the same. Declining to accept this comment, the government explains in the preamble to the final regulations that the historical differences between the two regimes have been overtaken by the similarities, observing that the RRTA Tier 1 tax is now identical to the FICA tax and that the exceptions to the two definitions are virtual mirror images of one another. Nevertheless, the preamble concludes, “Because the two statutes are not completely identical, the language of the regulation indicates that the term compensation has the same meaning as the term wages, except as specifically limited by the Railroad Retirement Tax Act.” (59 Fed. Reg. 66188, 66188 (Dec. 23, 1994).) The amended regulatory definition now reads: “The term compensation has the same meaning as the term wages in section 3121(a), determined without regard to section 3121(b)(9), except as specifically limited by the Railroad Retirement Tax Act (chapter 22 of the Internal Revenue Code) or regulation. The Commissioner may provide any additional guidance that may be necessary or appropriate in applying the definitions of sections 3121(a) and 3231(e).” (Treasury Regulation Section 31.3231(e)-1(a)(1).)

The Supreme Court Opinion

The court’s opinion in favor of the railroad, penned by Justice Neil Gorsuch, is decidedly and expressly textual, noting at the outset that the court’s “job it is to interpret the words consistent with their ‘ordinary meaning...at the time Congress enacted the statute’” (quoting Perrin v. United States, 444 U.S. 37, 42 (1979)) and proceeding to review Depression-era dictionary definitions of “money.”

The government’s argument to the court relied heavily on the exception from “compensation” for remuneration paid on account of qualified stock options. The government argued that interpreting “compensation” to exclude stock-based remuneration would make the qualified stock option exception meaningless. The court dismissed this contention with the suggestion that the exception was meant for cash payments generated by fractional shares payable to an employee in connection with the exercise of a qualified stock option. As the government pointed out, this is a remarkably narrow meaning to assign to this exception. When the exception was added to FICA, FUTA, and the RRTA by the American Jobs Creation Act of 2004, the conference report offered a different rationale. The report explained the purpose of the new provision as addressing the absence of a payroll tax exception (FICA and FUTA are noted in the text and the corresponding change to the RRTA is acknowledged in a footnote) for the proceeds “paid to an employee arising from the exercise of a statutory stock option,” which had created uncertainty as to employer withholding obligations upon the exercise of statutory stock options. In rejecting the the IRS’s assertion, the court did not discuss this legislative history but declined to engage in a “guessing game” concerning the purpose of the exception. Rather, the court returned the assertion to the IRS, pronouncing that it is the IRS’s interpretation that leaves the word at the heart of the controversy—“money”—as superfluous.

It is not clear that the IRS’s interpretation leaves “money” with no meaning. When the term “money remuneration” was codified, railroad workers received benefits that workers in other industries did not receive, such as free transportation, a difference acknowledged during the hearings that preceded the RRTA’s enactment. The railroad pension plans federalized by the RRA defined compensation to exclude the value of these in-kind fringe benefits. (Petition for Writ of Certiorari at 5.) If limiting RRTA taxation to “money remuneration” was meant to shelter these benefits from RRTA taxation out of fairness to railroad employees because the benefits were not taken into account in crediting pension benefits, then the RRB’s view of these benefits, as communicated in its April 22, 1938, letter, becomes particularly relevant. At that time, the RRB advised that stock should be taken into account when “received by such employees as a part of their agreed compensation for services actually rendered and at a definite agreed value.” Similarly, the current RRA regulations count these benefits as compensation, provided the employee agrees to be compensated in this manner and upon the value of the benefit. Given this history, the logical conclusion of the court’s view seems to be that since 1938, the RRA has exceeded its statutory authority in interpreting “money remuneration.” The court, however, does not say this. Rather, and perhaps to avoid accusing the 1938 RRB of acting beyond its mandate, the court reconciles its view with the RRB opinion by concluding that the RRB was, in fact, not interpreting “money remuneration” at all but rather adding a new category of compensation because “money remuneration” could not include that new category in the first instance. The court does not explain how the RRB was so empowered to augment the statute.

This somewhat forced reconciliation leaves the reader with the sense that, even in 1938, “money remuneration” may have been a sufficiently ambiguous term as to merit regulatory interpretation. The decision does briefly consider whether the court should defer to the IRS’s regulatory definition. First, the court rejects the application of Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984), on the ground that there is no statutory ambiguity, leaving no hole to be filled by regulations. Second, the court points to the text of the regulation, which states, “[t]he term compensation has the same meaning as the term wages in section 3121(a), determined without regard to section 3121(b)(9), except as specifically limited by the Railroad Retirement Tax Act“ (emphasis added), opining that the regulations themselves are limited by statutory textual differences, such as the one at issue. Accordingly, the decision does not invalidate the RRTA regulations but rather disagrees with how the IRS sought to apply those regulations to compensatory stock.

The interpretation of “money” is a question that rather effectively separates the textualists from the pragmatists. Justice Gorsuch limits his analysis to what “money” meant in 1937 to the drafters holding the pen. In contrast, the Seventh Circuit decision that was overturned, penned by Judge Richard Posner, allowed that the meaning of money has evolved, both before and after the enactment of the RRTA, observing, “The dictionary definition of money may remain constant while the instruments that comprise it change over time: sheep may have once been a form of money; now stock is.” Wisconsin Central Ltd. V. United States, 856 F. 3d 490, 492 (7th Cir. 2017). That is, even if the drafters had a 1937 concept of money, it is not clear that the drafters meant to freeze that moment in time. Nevertheless, that is what the decision purports to do.

Implications

The Wisconsin Central decision has both academic and practical implications.

Because most compensatory stock would seem to satisfy the RRA rules to be taken into account in determining a railroad employee’s compensation, one wonders whether the Wisconsin Central decision creates a new disconnect between the RRTA and the RRA by taxing less compensation than necessary to fund the intended benefit. That is, stock compensation will not be taxed under the RRTA but, if the RRA regulatory requirements are satisfied, the same compensation may increase the employee’s average monthly compensation. This disconnect is likely negligible, however, because employees receiving stock compensation may well have exceeded both the RRTA Tier 2 taxable wage base and the Tier 2 maximum earnings base without regard to the stock compensation. Further, unlike the Social Security Trust Funds, the railroad retirement system is currently projected to experience no cash flow problems during the next 25 years. Nevertheless, it may make sense for the RRB to align the RRA definition of compensation with the RRTA definition, as limited by the Wisconsin Central decision.

The Wisconsin Central decision suggests that the IRS (and other regulating agencies) should expect more scrutiny of certain pragmatic regulatory interpretations. Aligning FICA “wages” with RRTA “compensation” made sense and was consistent with certain principles of good tax policy. That is, the interpretation was equitable, simple, and administrable. Had the court acknowledged that “money remuneration” is sufficiently ambiguous as to allow the Chevron doctrine to apply, it seems that these principles ought to have carried some weight. Nevertheless, the court ruled as it did and the IRS will have to consider whether this regulatory approach will place the agency in a weaker litigating position when similar regulations are at issue.

On a more practical note, the Wisconsin Central decision does present a tax planning opportunity for railroad employers in a position to compensate employees with forms of pay that are not cash. Although stock compensation will be taxed to employees as ordinary income, neither the employees nor the employer will owe payroll taxes on the compensation. The decision appears to extend only to stock-settled compensation, leaving compensation such as cash-settled restrictive stock units still subject to RRTA taxation. Beyond stock compensation, railroad employers may want to consider other forms of non-cash compensation, such as property or taxable fringe benefits. In addition to planning for the future, railroad employers that did pay RRTA taxes on stock compensation should seek refunds of those taxes for open years and perfect any previously filed protective claims for refund.

Christa Bierma is a principal in Ernst & Young LLP’s National Tax Department in the Compensation & Benefits Group.

The views expressed are those of the author and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global Ernst & Young organization.