Teacher severance pay not subject to FICA.
Sec. 3101(a) imposes on every individual a Social Security tax on all "wages" received "with respect to employment)' Under Sec. 3121(a), "wages" means all renumeration for employment, including the cash value of all renumeration (including benefits) paid in any medium other than cash. The IRS argues that, under Sixth Circuit law, the phrase "remuneration for employment" should be interpreted broadly and must "include certain compensation in the employer-employee relationship for which no actual services were performed" (Gerbec, 164 F3d 1015, 1026 (6th Cir. 1999)). However, Ps believe that Gerbec does not control here, because they relinquished a tangible property interest in exchange for the payments; they rely on an Eighth Circuit decision (North Dakota State Univ., 255 F3d 599 (8th Cir. 2001)).
North Dakota: In that case, North Dakota State University (NDSU) offered an early retirement program to certain tenured faculty and high-level administrators. The district court determined that the retirement payments to NDSU administrators were FICA wages, because the administrators were "at will employees." However, the tenured faculty members had a recognized property interest in their tenure. The district court concluded that the payments to tenured faculty were made in exchange for the relinquishment of a property or contract interest, rather than for compensation and, as such, were not subject to FICA taxation.
In affirming the district court, the Eighth Circuit looked to the Service's determinations on whether FICA taxes were owed on severance payments made under a variety of circumstances (e.g., Rev. Rul. 58-301 (determining that FICA taxes were not payable on a lump-sum payment that prematurely terminated a five-year employment contract)). The North Dakota court noted that, unlike tenured professors, NDSU administrators could be terminated without cause subject only to an advance notice requirement, and, thus, their severance payments did not purchase any contract or property rights.
The professors, on the other hand, had achieved tenure that granted them lifetime appointments subject only to well-defined grounds for removal. Their tenure was a valuable right representing more than recognition for past service or performance; it was a right that had economic value to the employee, established at the outset of the tenure relationship and protected under state law. Thus, the court held that payments in exchange for relinquishing tenure rights under a contract were not wages for FICA purposes.
CSX Corp.: The IRS contends that the North Dakota court was incorrect when it concluded that payments that arose from the employment relationship should not be deemed wages. It relies on the reasoning of the Court of Federal Claims in CSX Corp., 52 Fed C1 208 (2002), which rejected the holding in North Dakota. However, we do not agree with the reasoning of CSX Corp. The principled method of distinguishing "wages" from other employer payments, as articulated in revenue rulings and fully discussed by the North Dakota court, is to focus on the payments' purpose. Payments for past or future service, or in recognition of past performance, are wages subject to the FICA tax; payments for other purposes are not.
Michigan courts consider tenure for public school teachers to be a property right. Tenure is itself a relationship between a teacher and his or her school district, but it arises by operation of state law. The rights granted by statute are the rights the plaintiffs relinquished in exchange for the payments at issue in this case. The illegal deprivation of those rights would have given rise to a cause of action for damages, and those damages recovered would not be taxable under the Sixth Circuit's reasoning in Gerbec. Likewise, the payments made for the sale of those rights would not constitute remuneration for employment, just as the payment made to buy out the remaining years of the five-year contract in Rev. Rul. 58-301 was not"wages" subject to FICA taxation.
Thus, the payments to Ps in exchange for their tenure rights under the early retirement incentive plans were not "wages" within the meaning of FICA, under Sec. 3121 (a). The refund claims should have been allowed.
PHYLLIS KLENDER, DC MI, 8/2/04
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|Title Annotation:||Federal Insurance Contributions Act|
|Publication:||The Tax Adviser|
|Date:||Dec 1, 2004|
|Previous Article:||Self-rental rule not affected by grouping activities.|