Academic journal article Suffolk University Law Review

Tax Law

Academic journal article Suffolk University Law Review

Tax Law

Article excerpt

Retired Tenured Professors' Early Retirement Plan Compensation Subject to Federal Insurance Contributions Act Taxation--University of Pittsburgh v. United States, 507 F.3d 165 (3d Cir. 2007)

The Federal Insurance Contributions Act (FICA) funds a national system of old age, survivors, disability, and hospital insurance, commonly known as social security and Medicare. (1) To achieve its purpose, FICA imposes a tax on both employers and employees at a level corresponding to a percentage of the employee's wages. (2) In University of Pittsburgh v. United States, (3) the United States Court of Appeals for the Third Circuit considered whether the payments of the University of Pittsburgh (University) pursuant to an early retirement plan (ERP) for its tenured professors constitute taxable "wages" under FICA. (4) The Third Circuit held that FICA taxation applies to ERPs because such benefits are compensation for services and thus constitute wages. (5)

From 1989 and 1999, the University implemented early retirement plans for the benefit of tenured professors and members of the administration. (6) The ERPs enabled the University to offer competitive compensation packages to new faculty and provide flexible retirement options to its existing faculty. (7) Under these plans, the University would compensate participants who chose early retirement with an amount correlating to the participant's salary at retirement and length of service to the institution. (8) As a condition of receiving this compensation, the University required all faculty participants to relinquish their tenure rights. (9) Tenure immunized faculty from termination without cause. (10)

From 1996 to 2001, the University paid more than $2 million in taxes on ERP payments to its tenured faculty.11 In 2001, the University requested a full refund; the Internal Revenue Service (IRS) denied the request. (12) In October 2004, the University responded by filing suit against the IRS in the United States District Court for the Western District of Pennsylvania. (13) The district court granted the University's motion for summary judgment, concluding that the payments it made pursuant to the ERPs did not constitute wages and therefore were not subject to FICA taxation. (14) The district court ordered the IRS to refund $2,088,358 to the University. (15) On appeal by the government, the Third Circuit reversed, holding ERP payments that require relinquishment of tenure status constitute wages under FICA. (16)

Congress intended that FICA taxation apply to a wide range of payments arising from the employment relationship. (17) The financial backbone of FICA is wages, which Congress defined as "all remuneration for employment, including the cash value of all remuneration paid in any medium other than cash." (18) The Supreme Court has construed the word "employment" to encompass the "entire employer-employee relationship for which compensation is paid to the employee by the employer." (19) Although the term "wages" comprises all compensation earned while at the service of another, wages do not necessarily include all income that one secures from his employment. (20) In assessing whether certain payments constitute FICA wages, courts consider the employer's method for calculating payments, the employer's motivation in awarding the benefits, the employee's eligibility for earning the compensation, and the nature of the employment relationship giving rise to the remunerations. (21) Applying these factors, courts have interpreted wages to include back pay, early-out payments, reduction-in-force compensation, supplemental unemployment benefits, and ERISA settlement payments. (22)

In addition to judicial guidance, the IRS, through its revenue rulings, sheds light on the definition of wages as it pertains to FICA taxation. (23) In Revenue Ruling 58-301, the IRS advised that an employer's payment to an employee to secure a mutual nullification of a multi-year employment contract does not constitute wages for FICA purposes. …

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