The Supreme Court, in a 5-4 decision reversing and remanding the Seventh Circuit judgment and resolving a circuit split, has held that stock options granted from railroads to their employees aren’t “any form of money remuneration” under Code Sec. 3231(e)(1) and thus are not subject to Railroad Retirement Tax.
Background. The Railroad Retirement Tax Act of 1937 (RRTA), which federalized private railroad pension plans, provides that private railroads and their employees pay a tax based on employees’ income in exchange for a pension from the federal government. (Code Sec. 3201, Code Sec. 3221) The tax is imposed on employee “compensation,” which is defined in Code Sec. 3231(e)(1) as meaning “any form of money remuneration.”
IRS issued a reg shortly after the RRTA’s enactment explaining that it taxes “all remuneration in money, or in something which may be used in lieu of money (scrip and merchandise orders, for example).” (26 CFR § 410.5 (1938)) The reg stated that the RRTA taxed certain money payments “related” to stock, but didn’t expressly extend that treatment to stock itself. (26 CFR § 410.6(f) (1938))
Reg. § 31.3231(e)-1 interprets the term “compensation” under the RRTA as having “the same meaning as the term wages” for purposes of the Federal Insurance Contributions Act (FICA), “except as specifically limited” by the RRTA. Code Sec. 3121(a) defines wages for FICA purposes as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash,” except as specifically excluded.
Facts. Many railroads have adopted employee stock option plans. A stock option, in general, consists of a right to buy a specified amount of stock at a specific price. The plan at issue in this case permitted an employee to exercise stock options in a number of ways, including by purchasing stock with his or her own money and holding it as an investment; purchasing stock but immediately selling a portion to finance the purchase; or purchasing stock at the option price, selling it all immediately at the market price, and taking the profits. A variation of the third exercise known as a “cashless exercise” allows an employee to simply have the option’s value (i.e., the difference between option and market price) paid directly into their bank account.
Parties’ arguments. The government argued that stock options like those at issue in this case qualify as a form of taxable “money remuneration” under the RRTA because stock can be easily converted into money.
The railroads, on the other hand, asserted that stock options aren’t “money” and thus aren’t compensation for RRTA purposes.
Majority holds stock options are excluded. The majority opinion of the Supreme Court (delivered by Justice Gorsuch, and joined by Justices Roberts, Kennedy, Thomas, and Alito) found that the plain language of the statute foreclosed treating the stock options as “money remuneration.” The Court consulted the 1933 edition of Black’s Law Dictionary, which defined “money” as any currency, tokens, bank-notes, or other circulating medium in general use as the representative of value—and easily concluded that “stock options do not fall within that definition.” The fact that the statute specifies money “remuneration” didn’t change this result because, in the context of the statute, “money” limits the types of remuneration that is subject to tax under the RRTA.
The majority also found that this interpretation was supported by the 1939 Internal Revenue Code’s adoption, two years after the RRTA, of several provisions that drew a clear distinction between “money” and “stock,” e.g., the definition of “stock of the corporation” as “property other than money.” In addition, the Court noted that the Federal Insurance Contributions Act (FICA), enacted by the same Congress that passed the RRTA, subjected to FICA tax “all remuneration,” and not just “money remuneration,” and said that this “choice to use the narrower term in the context of railroad pensions alone requires respect, not disregard.”
The Court said that the Seven Circuit “all but admitted that stock isn’t money,” but nonetheless decided that the options should fall within the RRTA’s scope on the basis that it made “good practical sense” for the statute to cover stock as well as money. The majority rejected that line of reasoning, stating that “[w]ritten laws are meant to be understood and lived by” and should be “interpreted as taking their ordinary, contemporary, common meaning… at the time Congress enacted the statute.” A contrary approach—like that taken by the Seventh Circuit—would allow a statute’s meaning to “shift with the latest judicial whim” and would essentially usurp Congress’s lawmaking authority.
Dissent would include stock options as compensation. The dissenting opinion (delivered by Justice Breyer, and joined by Justices Ginsburg, Sotomayor, and Kagan) would have concluded that the statute itself was ambiguous and that IRS’s interpretation of it—generally adopting the FICA definition of “compensation” for RRTA purposes and thus including stock options—was lawful. The dissent cited a different definition of money in the Oxford English Dictionary, as including “property or possessions of any kind viewed as convertible into money,” to contrast with the definition provided by the majority. According to the dissent, this contrast showed that the term “money” was ambiguous and that IRS’s interpretation to resolve that ambiguity was reasonable and entitled to deference. (Chevon U.S.A. v. Natural Resources Defense Counsel, Inc., (Sup Ct 1984) 467 U.S. 837)
The dissent also found that IRS’s interpretation was supported by the purpose of the RRTA, as well as by regs promulgated by the Railroad Retirement Board in 1938 treating “a commodity, service, or privilege” that had an “agreed upon” value as included in “any form of money remuneration.”
References: For wages defined for FICA purposes, see FTC 2d/FIN ¶ H-4621; United States Tax Reporter ¶ 31,114. For the Railroad Retirement Tax Act, see United States Tax Reporter ¶ 34,014.
