Supreme Court: Railroad Company Stock Options Aren’t Taxable for RRTA Purposes

Clarification: The original version of this blog entry may have given readers the impression that the Supreme Court ruling exempted stock options at railroad companies from all US taxes, including federal income tax. The ruling applies only to taxation of options under the Railroad Retirement Tax Act. This is a tax that is paid only by railroad companies and their employees that is used to fund pensions for railroad workers, as described below. It is only this tax that the ruling addresses. Stock options held by railroad workers are still subject federal income tax. The entry has been modified to clarify this.

There’s some buzz around stock options this week, centering on a U.S. Supreme Court Ruling (Wisconsin Central Ltd, v. U.S., S Ct. No. 17-530, 6/21/18) that stock options issued to railroad company workers are not taxable compensation for purposes of the Railroad Retirement Tax Act.

If you just let out a “What?” you are not alone. How is it that the taxation of stock options (or not) is now seemingly industry specific? The answer to that question lies in the history books—back in time just over 80 years ago.

In order to understand this ruling, we need to familiarize ourselves with parts of the Railroad Retirement Tax Act of 1937. This legislation was enacted by Congress to protect railroad workers in the wake of the Great Depression. According to a Thomson Reuters memo on the topic (“Supreme Court: employee stock options aren’t “compensation” under RRTA,” June 22, 2018): “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.'" (Because railroad workers receive a pension and medical benefits under the RRTA, they generally don't participate in Social Security and Medicare and railroad workers and/or companies generally are not subject to FICA, FUTA, or SECA.)

Returning to the present day, the RRTA has been in effect since it was enacted back in 1937. The case at hand began when several railroads filed a refund claim with the IRS, citing overpayment of Railroad Retirement taxes. The railroads said that they overpaid their taxes because the tax calculation included the value of employee stock options.

In response, the IRS denied the railroad companies’ request for tax refunds, arguing that the employee stock options were indeed taxable as “money remuneration” under the Act. Furthermore, the IRS suggested that the stock options can be exercised and therefore easily converted into money (money remuneration).  The railroads maintained their position that stock options are not money. This became the key debate—whether stock options are considered “money remuneration” under the RRTA.  Part of the railroad companies’ argument focused on the fact that when Congress passed the Act back in 1937, it sought to mimic what were the existing industry pension practices in place at that time. Those practices generally ignored or overlooked certain in-kind benefits like food, lodging and railroad tickets for tax purposes.

The U.S. Supreme Court reversed lower court rulings and ruled that stock options provided to railroad employees under the RRTA are not money remuneration, and are therefore not subject to taxation under the RRTA. You now have the answer as to how one industry can have different tax treatment for their employee stock options than other industries.

Thank you to Bruce Brumberg of mystockoptions.com who first alerted me to the Supreme Court ruling.