Stock options not taxable income under RRTA

By James A. Beavers, CPA, CGMA, J.D., LL.M.

The Supreme Court held that employee stock options are not taxable compensation under the Railroad Retirement Tax Act.


During the Great Depression, railroads' pension funds were under extreme financial pressure and were on the brink of insolvency. Because of the railroads' importance to commerce and the large numbers of people employed by them at the time, Congress took steps to alleviate the crisis, adopting the Railroad Retirement Tax Act of 1937 (the RRTA). The RRTA, which remains in force today (Secs. 3201 through 3241), federalized private railroad pension plans, imposing a payroll tax on private railroads and their employees. The tax proceeds are used to pay retirement and disability benefits to railroad workers.

At the time of the RRTA's adoption, in addition to paying their employees in money, railroads often also compensated them with in-kind benefits such as meals, transportation, and lodging. However, in determining workers' pensions, railroads typically did not take into account the in-kind benefits. The RRTA's scheme mirrored this arrangement and did not include the in-kind benefits in calculating employees' pensions. Likewise, the RRTA did not subject the in-kind benefits to the payroll tax. Instead, the RRTA taxed only "compensation" and limited the definition of that term to "any form of money remuneration" (Sec. 3231(e)(1)). Although the statute has been amended over the years, the original statutory definition of compensation has not been changed.

Wisconsin Central Ltd., Grand Trunk Western Railroad Company, and Illinois Central Railroad Company, all U.S. subsidiaries of Canadian National Railway Company, adopted nonqualified employee stock option plans in the 1990s to encourage employee performance and align employee and corporate goals. Under these plans, employees were issued stock options that they could exercise to purchase stock in Canadian National Railway Company for a fixed price (the strike price). Employees could choose one of several ways to pay the strike price when exercising the options (including selling some of the stock they received), but regardless of the method chosen, the railroads only transferred stock, not money, to the employees.

In 2014, the railroads filed a claim for refund in district court for the approximately $13 million in RRTA taxes they had paid or withheld in the years 2006 through 2013 when they transferred stock to employees who exercised stock options. The railroads claimed that the stock transfers were not "money remuneration" and therefore were not taxable. The IRS argued that the stock qualified as "money remuneration" under the RRTA because stock can easily be converted into money. The district court sided with the IRS, finding the term "money remuneration" in the RRTA was ambiguous, and the IRS's interpretation of the statute was entitled to deference under Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984).

The railroads appealed the decision to the Seventh Circuit, which affirmed the district court. The court recognized that stock may not have been considered a form of money remuneration at the time the RRTA was enacted; however, it also found that stock has become the practical equivalent of money and that there was no reason to believe that Congress had meant "money remuneration" to exclude stock if stock became the equivalent of cash. The railroads appealed the Seventh Circuit's decision to the Supreme Court, which agreed to hear the case.

The Supreme Court's decision

The Supreme Court held that employee stock options are not taxable compensation under the RRTA because they are not money remuneration. Adhering to the canon of statutory construction that words in a statute should generally be interpreted as taking their ordinary, common meaning at the time of the enactment of the statute, the Court analyzed the term "money remuneration" to determine what it meant at the time Congress enacted the RRTA.

Based on definitions of "money" from general and legal dictionaries published around the time the RRTA was enacted, and a definition from the case Railway Express Agency, Inc. v. Virginia, 347 U.S. 359 (1954), the Court concluded that when the RRTA was adopted in 1937, the word "money" was understood to mean currency "issued by [a] recognized authority as a medium of exchange." The Court found it obvious that stock options do not fall within that definition, pointing out that few people used stock to "buy groceries or pay rent or value goods and services in terms of stock" and noting that, for tax purposes, the IRS did not treat stock options as a medium of exchange.

The Court also found that adding the word "remuneration" did not change the analysis. It reasoned that the word "money" modified the word "remuneration." Thus, "money" limits the kinds of remuneration that will qualify for taxation, rather than "remuneration" expanding what is treated as "money." The Court explained, "When the statute speaks of taxing 'any form of money remuneration,' then, it indicates Congress wanted to tax monetary compensation in any of the many forms an employer might choose — coins, paper currency, checks, wire transfers, and the like. It does not prove Congress wanted to tax things, like stock, that aren't money at all."

According to the Court, the broader statutory context pointed to the same conclusion. For example, the 1939 Internal Revenue Code, part of the same title as the statute in question and adopted just two years after it, expressly treated "money" and "stock" as different things. In addition, the Federal Insurance Contributions Act (FICA), the companion statute to the RRTA, makes "all remuneration," including benefits "paid in any medium other than cash" subject to tax. This indicated that Congress, when it enacted FICA and the RRTA, was well aware of the difference between "money" and "all" forms of remuneration, and its choice to use the narrower term in the RRTA but not in FICA "requires respect, not disregard."

The Court further observed that the IRS, in a regulation explaining what the RRTA taxed, gave as examples salaries, wages, commissions, fees, and bonuses (former Regs. Sec. 410.6(a) (1938)). However, nowhere in the regulation was it suggested that stock was taxable. This was significant in the Court's eyes because, based on the fact that the regulations stated that the RRTA tax did apply to "payments related to stock," the IRS knew that taxing stock was a possibility but did not seek to do so in the regulation.

The government argued that while money remuneration often means remuneration in a commonly used medium of exchange, sometimes, as in the case of the RRTA, money remuneration means any property of any kind that can be converted to money or has a value expressed in terms of money. While the Court acknowledged that the term "money" might sometimes be used in the way the government suggested, it was not the way it was ordinarily used at the time the RRTA was adopted, and the government had provided no persuasive proof that Congress intended to invoke this "idiosyncratic definition."

The government's argument relied on exemptions from tax in the RRTA, including the exemption from the tax for qualified stock options in Sec. 3231(e)(12). The government contended that since the RRTA excludes qualified stock options from taxation, to avoid superfluity, it must include in taxation other sorts of stock options like the nonqualified stock options issued by the railroads.

The Court found fault with this argument because the exemption in Sec. 3231(e)(12) covers "any remuneration on account of" qualified stock options (emphasis by the Court). As the government conceded, the exemption could apply to monetary payments made for fractional shares, so the Court found that the exemption was not inconsistent with the interpretation that "money remuneration" did not include stock. The government's counterargument to the Court's position was that Congress would not have bothered writing such a small exemption, and that Congress must have assumed that stock options would qualify as money remuneration without a specific exemption. The Court, however, stated it would not join the government's "guessing game," explaining that it was not the courts' function to rewrite constitutionally valid statutory text based on speculation about what Congress might have intended.

Finally, the government argued that the Court should give Chevron deference to Regs. Sec. 31.3231(e)-1, promulgated in 1994, in which the IRS interpreted "compensation" under the RRTA as having "the same meaning as the term wages in" FICA "except as specifically limited by the Railroad Retirement Tax Act." Under Chevron, if a statute is silent or ambiguous regarding an issue, a court must give deference to a reasonable interpretation of the statute by an agency charged with administering the statute.

The Court found that "in light of all the textual and structural clues before us" that the statute was not ambiguous about the meaning of money, and thus the Court was not required to give deference to the IRS interpretation in the regulation. Further, the Court observed that the regulation itself would not help the government because "FICA's definition of wages — 'all remuneration' — is 'specifically limited by the Railroad Retirement Tax Act,' which applies only to 'money remuneration.' " Therefore, in the Court's view, the regulation did not expand the definition of "money remuneration" to include stock.


The dissent in the case claimed that the Court's decision would leave taxpayers, with respect to the RRTA, "trapped in a monetary time warp, forever limited to those forms of money commonly used in the 1930s." As the Court explained, this is not the case. Although the definition of the word money is fixed, "new applications may arise in light of changes in the world." Thus, "money" as used in the statute must be a "medium of exchange," but what qualifies as a "medium of exchange" may change over time. The Court found that the problem with treating stock and stock options as money was not that they were not commonly used when Congress enacted the RRTA, but that they were not at that time and are not now recognized as mediums of exchange.

Wisconsin Central, Ltd., No. 17-530 (U.S. 6/21/18)

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