The U.S. Supreme Court is poised to resolve a split between the Seventh and Eighth Circuits related to a federal program that is a well-kept secret. Nothing as intriguing as Russian spies or hacked emails… but, I think, interesting nonetheless.
Of course, you have heard about the Social Security system. And you probably know that U.S. employers pay and withhold taxes under the Federal Insurance Contributions Act (FICA) to fund Social Security and Medicare benefits for retired workers in the U.S. But what you may not know, however, is that around the same time that the Social Security system was being put in place, the federal government established a separate program to shore up railroad companies’ pension obligations.
At that time, in the 1930s, more than 80% of U.S. railroad workers were employed by private companies with pension plans, but the plans were in shambles. According to the Social Security Administration,
“benefits were generally inadequate, liable to capricious termination, and of little assistance to disabled employees. When the Great Depression drove the already unstable railroad pension system into a state of crisis, the railroad industry was beset by retirees who needed immediate assistance.”
Since the planned Social Security system would not cover work performed before 1937 and was not scheduled to begin paying benefits for several years, Congress enacted the Railroad Retirement Tax Act (RRTA), federalizing the retirement program for railroad workers. Employers covered by the RRTA generally are exempt from FICA.
So, that is the interesting, high-level contextual backdrop for a narrow, technical question that the Supreme Court will address. That question is whether stock received upon the exercise of stock options that railroads award to their employees as part of their compensation package is taxable compensation under the RRTA.
The RRTA is similar to FICA in that both impose a payroll tax on employers and employees to pay for employee benefits. Like FICA with respect to other employers, the RRTA requires railroads to pay an excise tax equal to a specified percentage of its employees’ compensation and to withhold a specified percentage of that compensation as the employees’ share of the tax.
But there is a key difference. The RRTA defines taxable compensation as any form of money remuneration paid to an individual for services rendered to an employer. In contrast, FICA taxes all remuneration for employment and explicitly includes the cash value of all remuneration (including benefits) paid in any medium other than cash. Thus, income from stock options clearly is taxable under FICA.
The circuits, however, are split on whether income from stock options is covered by the term money remuneration, making it taxable under the RRTA.
The Seventh Circuit held that it is. In its view, stock should be treated the same way under the RRTA and FICA, as there is no significant economic difference between receiving $1,000 in cash and $1,000 worth of stock (see: Wisc. Cent. Ltd. v. United States, 856 F.3d 490 (7th Cir. 2017)).
The Eighth Circuit, however, has recognized the language differences between FICA and the RRTA and held that money remuneration should be given its plain-language meaning: cash (or some other generally recognized medium of exchange) but not stock. The court acknowledged that stock has cash value and can be exchanged for money, but asserted that it is not a medium of exchange, noting that no one pays for groceries with stock (see: Union Pac. R.R. Co. v. United States, 865 F.3d 1045 (8th Cir. 2017)).
Until the issue is resolved, some railroads and railroad employees must pay federal taxes on stock awarded while others need not. The Supreme Court has granted cert to review the Seventh Circuit opinion in order to resolve this difference… which could have consequences that reach well beyond the little-known RRTA.