On March 4, 2019, the U.S. Supreme Court held in BNSF Railway Co. v. Loos that a railroad’s payment to an employee for work time lost due to an on-the-job injury is taxable compensation under the Railroad Retirement Tax Act (RRTA).

In the case, an employee sued his railway employer under the Federal Employers’ Liability Act (FELA) for injuries he received while working at the company's railyard. A jury awarded him damages, of which approximately a quarter was awarded as wages lost during the time he was unable to work. The railway contended that the lost wages portion of the judgment constituted “compensation” taxable under the RRTA and asked that taxes be withheld from that portion to cover the employee’s share of RRTA taxes. The district court and Eight Circuit Court of Appeals rejected the requested offset, but the Supreme Court reversed.

Supreme Court's Decision

The Court's majority and the dissent differed on how to frame the case. The majority focused on the employment relationship and “services,” while the dissent focused on the employee’s injury and negligence.

The majority began by analyzing the history of the RRTA. The RRTA funds retirement benefits for railroad workers by imposing a payroll tax on both railroads and their employees, referring to the railroad’s contributions an “excise” tax, and the employee’s share as an “income” tax. Taxes under the RRTA and benefits under the Railroad Retirement Act are measured by the employee's "compensation," which the statutes both define as “any form of money remuneration paid to an individual for services rendered as an employee.”1 The Court noted that one year after the RRTA’s adoption, the IRS stated that “compensation” is not limited to pay for active service but also reaches pay for periods of absence.2 Indeed, current IRS regulations provide “[t]he term compensation is not confined to amounts paid for active service, but includes amounts paid for an identifiable period during which the employee is absent from the active service of the employer.”3

The Court then analogized the statutory foundation of the railroad retirement system to the Social Security System, wherein the Federal Insurance Contributions Act (FICA) taxes employers and employees to fund benefits distributions pursuant to the Social Security Act (SSA). Tax and benefit amounts are determined by the worker’s “wages,” the social security equivalent to “compensation.” Both the FICA and SSA define “wages” using language similar to the RRTA and Railroad Retirement Act definitions of “compensation.”4 As such, the Court addressed how “compensation” should be interpreted for purposes of the RRTA by analyzing two cases that interpreted the term “wages” for Social Security purposes: Social Security Bd. v. Nierotko, 327 U. S. 358 (1946) and United States v. Quality Stores, Inc., 572 U. S. 141 (2014).

In Nierotko, the Court held that “wages” included pay for active service as well as back pay for time lost due to the “employer’s wrong.” In Quality Stores, Inc., severance pay was found to qualify as “wages” taxable under FICA. Reasoning from these cases, the Court concluded that “compensation” under the RRTA encompasses pay for active service, as well as pay for periods of absence from service, provided the remuneration in questions stems from the employer-employee relationship.

The Dissenting Opinion

In dissent, Justice Gorsuch focused on the injury at issue and the alleged negligence of the railroad. The dissent argued that when an employee suffers a physical injury due to his employer’s negligence and has to sue in court to recover damages, the final judgment should be considered compensation for his injury rather than for services never rendered. The dissent analyzed the terms “service” and “remuneration” in the definition of the term “compensation.” A “service” refers to “duty or labor …by one person…bound to submit his will to the direction and control of [another].”5 “Remuneration” means “a quid pro quo,” “recompense” or “reward” for such services.6 The dissent reasoned that “remuneration for services rendered” covers things like salary or hourly wages, as well as benefits like sick or disability pay because those benefits are offered to attract and keep employees working on the employer’s behalf. However, damages for negligence are different because a dangerous fall or wrenching of a knee are not services rendered to the party who negligently caused them. Therefore, the dissent concluded that the judgment obtained by the employee was unconnected to any service the employee rendered to the railway. The dissent further noted that allowing for “asymmetric tax treatment” could result in an increased incentive to settle FELA cases because defendants could “sweeten their settlement offers while offering less money” by allocating smaller portions of settlement payments to taxable lost wages.

Although the majority found the IRS’s interpretation in accord with its own, it did not rely upon it. Rather, it engaged in its own statutory interpretation. Justice Gorsuch closed his dissent by praising the majority’s refusal to apply Chevron deference: “instead of throwing up our hands and letting an interested party—the federal government’s executive branch, no less—dictate an inferior interpretation of the law … my colleagues rightly afford the parties before us an independent judicial interpretation of the law. They deserve no less.”

How Does this Decision Affect Employers?

Key takeaways from the ruling are that compensation for time spent not working are likely subject to tax when there is an employer-employee relationship, regardless of the reason why the employee was not working. The Court also put to rest any lingering doubt that it made a difference that the payment was the result of a legal obligation in the form of a judgment versus a voluntary payment in the form of a settlement. The Court thus created parity for the tax treatment of the payment regardless of why it was made.