High Court to Decide If Rail Stock Options Qualify as Pay

(CN) – The Supreme Court agreed Friday to decide whether money earned by a railroad employee’s exercise of stock options should be treated as employee compensation for purposes of paying payroll taxes.

The issue boils down to whether stock options should be considered “monetary remuneration.”

For former U.S. Circuit Judge Richard Posner of the Seventh Circuit, the matter was clear.

“A $10 bill is paper; so is a stock certificate that can be sold for $10,” Posner said in one of his last opinions published before his retirement. “The dictionary definition of money may remain constant while the instruments that comprise it change over time: sheep may have once been a form of money; now stock is.”

Under the Railroad Retirement Tax Act, railroad employees are entitled to railroad retirement benefits in lieu of Social Security benefits.

Just like other employers pay a payroll tax to cover a portion of an employee’s Social Security dues, railroads pay an excise tax equal to a certain percentage of its employees’ wages to cover retirement costs.

In 1996, subsidiaries of the Canadian National Railway Co. – Wisconsin Central Ltd., Illinois Central Railroad Co., and Grand Truck Western Railroad Co. – began including stock options in their employee compensation plans, which can only be exercised if the company achieves certain goals.

The IRS classified these stock options as employee compensation, and ordered the railroads to pay the excise tax on the value of stock options as if they were wages.

On the railroads’ challenge, a federal judge ruled for the government, and a divided Seventh Circuit panel affirmed last July.

“The government’s position makes good practical sense by avoiding the creation of a tax incentive that might distort the ways in which employers structure compensation packages for their managers,” Posner wrote at the time.

The judge admitted that the legislators who wrote the Railroad Retirement Tax Act, enacted in the middle of the Great Depression when the value of corporate stock was quite low, may not have considered stock to be a form of monetary compensation.

But today, “the equivalence of stock to cash is actually signaled in the statutory exception for qualified stock options, explicitly divorced from ‘money remuneration’ by 26 U.S.C. § 3231(e)(12),” Posner wrote.

That exception implies that non-qualified stock options, which are the kind at issue in this case, are taxable, the opinion states.

U.S. Circuit Judge David Manion dissented, saying, “Our job is to interpret the Act as it would have been understood by people at the time it was enacted, not to speculate about the intent of Depression‐era legislators.”

Manion argued that “the plain language of the statute’s definition of ‘compensation’ does not cover stock or stock options.”

The Railroad Retirement Tax Act defines “compensation” as “any form of money remuneration paid to an individual for services rendered as an employee to one or more employers.”

Per its custom, the Supreme Court did not issue any comment Friday in taking up the case.

The railroads are represented by Thomas H. Dupree, Jr. with Gibson, Dunn & Crutcher. The federal government is represented by Solicitor General Noel J. Francisco.

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