Payment of an award for lost working time is taxable compensation

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

The Supreme Court held that the payment of an award to a railroad employee for working time lost due to an on-the-job injury is taxable "compensation" under the Railroad Retirement Tax Act (RRTA) (Secs. 3201 through 3241).

Background

Michael Loos worked for the BNSF Railway Co. in a railyard. In December 2010, Loos fell into a hidden drainage grate while working and injured his knee. He missed work for many months, and upon his return he had a series of absences, many of which he attributed to knee-injury flareups. In December 2013, Loos sued BNSF under the Federal Employers' Liability Act (FELA) for negligently causing his knee injury and won a $126,213 jury verdict. Of that amount, the jury allocated $30,000 to wages lost during the time Loos was unable to work.

BNSF moved for an offset against the judgment. The railway asserted that the lost wages awarded Loos constituted "compensation" taxable under the RRTA and therefore it was required to withhold a portion of the $30,000 attributable to lost wages to cover Loos's share of RRTA taxes, which came to $3,765. A district court and, on appeal, the Eighth Circuit, rejected the requested offset, holding that an award of damages compensating an injured railroad worker for lost wages is not taxable under the RRTA. BNSF appealed the Eighth Circuit's decision to the Supreme Court, which due to a circuit split on the question, agreed to hear the case.

The railroad retirement benefit program

Under the railroad retirement benefit program, the RRTA and the Railroad Retirement Act (RRA) (45 U.S.C. Ch. 9) work together to ensure that retired railroad workers receive their allotted pensions and benefits. The RRTA funds the program by imposing a payroll tax on railroads (Sec. 3221, referred to as an excise tax) and their employees (Sec. 3201, referred to as an income tax). The RRA provides railroad workers various benefits and sets out the eligibility requirements for them.

Taxes under the RRTA and benefits under the RRA are measured by the employee's "compensation." The RRTA and RRA separately define compensation, but in language that has basically been unchanged since 1937, both statutes state that the term means "any form of money remuneration paid to an individual for services rendered as an employee" (Sec. 3231(e)(1); 45 U.S.C. §231(h)(1)).

IRS's interpretation of compensation: In its interpretation of compensation for purposes of the RRTA, the IRS has since the beginning taken the position that compensation for these purposes is not limited to pay for active services, but also includes pay for periods of absence. In 1994, the IRS specifically added language to Regs. Sec. 31.3231(e)-1(a)(4) that states that compensation includes "pay for time lost."

The Eighth Circuit's interpretation of compensation: The Eighth Circuit disagreed with the IRS regarding the meaning of compensation. It determined that "compensation" for RRTA purposes includes only pay for "services that an employee actually renders," or, in other words, pay for active service. Consequently, the court held that "compensation" for RRTA purposes does not include pay for periods of absence (Loos v. BNSF Railway Co., No. 15-3355 (8th Cir. 8/3/17)).

The Eighth Circuit came to this conclusion based on amendments that Congress made to the RRTA. While the RRTA's original language stated that compensation included payments made to railroad employees for time lost, in two amendments, the first in 1975 and the second in 1983, Congress removed the references to "pay for time lost" from the definition of compensation. The Eighth Circuit reasoned that these deletions showed that compensation no longer includes pay for time lost.

Loos's interpretation of compensation: Loos, like the Eighth Circuit, interpreted compensation as not including pay for time lost, but he did so for different reasons. Loos stated that "remuneration . . . for services rendered" in the definition of compensation in the statute referred to the package of benefits an employer pays "to retain the employee." This means benefits such as sick pay and vacation pay were taxable compensation, but FELA damages were not because they are compensation for an injury rather than for services rendered. Loos argued in the alternative that even if voluntary settlements qualify as "compensation," "involuntary payment[s]" in the form of damages do not.

In a final fallback position, Loos also argued that the exclusion of personal injury damages from "gross income" for federal income tax purposes, under Sec. 104(a)(2), should carry over to the RRTA's tax on the "income" of railroad workers. Since the payments for lost time that he was awarded in his FELA suit were compensation for personal injuries, he claimed that they were not taxable RRTA compensation.

The Supreme Court's decision

In a 7-2 decision, the Supreme Court held that "compensation" for RRTA purposes includes an employer's payments to an employee for active service and for periods of absence from active service, regardless of whether the employer chooses to make the payment or is legally required to do so. Thus, the portion of Loos's FELA recovery allocated to pay for lost time was taxable RRTA compensation.

In making its determination, the Court started with the RRTA's statutory text. Because the definition of compensation in the RRTA is materially indistinguishable from the Federal Insurance Contributions Act (FICA) definition of wages, the Court followed two of its cases in which it had addressed whether certain awards of income were included in wages for FICA purposes: Social Security Bd. v. Nierotko, 327 U.S. 358 (1946), and Quality Stores, Inc., 572 U.S. 141 (2014). Based on these cases, the Court held that "compensation" under the RRTA encompasses not simply pay for active service but, in addition, pay for periods of absence from active service, provided that the remuneration in question stems from the "employer-employee relationship" (Nierotko, 327 U.S. at 366).

The Supreme Court found that "[d]amages awarded under the FELA for lost wages fit comfortably within this definition" (slip op. at 6). If a railroad negligently fails to maintain a safe railyard and a worker is injured as a result, the FELA requires the railroad to compensate the injured worker for, among other things, working time lost due to the employer's wrongdoing. Thus, FELA damages for lost wages are functionally equivalent to an award of back pay, which the Court had held in Nierotko was within the definition of "wages." Because wages are defined the same for FICA purposes as compensation for RRTA purposes, Loos's damages for lost wages were taxable RRTA compensation.

Regarding the deletions of references to "time lost" in 1975 and 1983, which were relied on by the Eighth Circuit, the Court found that the Eighth Circuit had misread Congress's intentions. According to the Court, Congress had revealed no intention to exclude payments for time lost from compensation in deleting the references to lost wages. The changes made by Congress were intended, in 1975, to make compensation taxable when paid rather than earned and, in 1983, to make the wage base annual rather than monthly. The removal of the references to "time lost" were incidental to those changes.

Moreover, the RRTA's text, as amended, continues to indicate that "compensation" encompasses pay for time lost, because it excludes from "compensation" a limited subset of payments for time lost, notably certain types of sick pay and disability pay. These enumerated exclusions would be entirely superfluous if the RRTA broadly excludes from "compensation" any and all pay received for time lost. Also, although Congress did not amend the RRTA's sister statute, the RRA, to remove the references in it to pay for time lost, the failure to reconcile the statutes was "inconsequential" and given the specific exclusions included in the RRTA of certain types of income from taxable compensation, did not signal that pay for time lost was not taxable compensation.

Regarding Loos's argument that the pay for lost work should be treated as compensation for an injury, and thus not taxable RRTA compensation, the Supreme Court found that this argument was undermined by its decision in Nierotko. The Court explained that it had based its decision in that case on the fact that the back pay the employee received was to redress a loss of wages due to the employer's wrong, which was analogous to the payment for time lost. The Court further found that, applying the reasoning in Nierotko to Loos's facts, "there should be no dispositive difference between a payment voluntarily made and one required by law" (slip op. at 11).

The Supreme Court also rejected Loos's final argument based on the Sec. 104(a)(2) exclusion for personal injury damages from gross income. The Court explained that the RRTA uses the term "income" merely to distinguish the "income" tax on an employee from the matching "excise" tax on a railroad, and observed that Congress specified not "gross income" but employee "compensation" as the tax base for RRTA taxes. Thus, Congress did not exclude personal injury damages from RRTA "compensation" through Sec. 104(a)(2).

Reflections

The majority's opinion relies on the position that Congress's amendments to the language of the RRTA in 1975 and 1983, which removed references to payments for time lost, had no effect on the statute's treatment of lost wages as compensation. A dissent by Justice Neil Gorsuch, joined by Justice Clarence Thomas, disputed this idea. According to the dissent, by taking this position, the Court was reading back "into the law words (time lost, personal injury) that Congress deliberately removed on the assumption they were never really needed in the first place" and that to supply such an omission "transcends the judicial function."

BNSF Railway Co. v. Loos, No. 17-1042 (U.S. 3/4/19)

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