Procedure & Administration

Service Modifies AOD on Teachers’ Severance Pay

In an Action on Decision (AOD) published on Jan. 18, 2007, the Service modified its litigating position on cases involving early-retirement payments to tenured faculty members in the Eighth Circuit.

Background

In North Dakota State University, 255 F3d 599 (8th Cir. 2001), the Eighth Circuit held that early-retirement payments made to tenured faculty members were not wages subject to withholding. In an AOD published on Dec. 31, 2001, the Service did not acquiesce in the Eighth Circuit’s decision. Nevertheless, it recognized the precedential effect on cases appealable to that circuit, and acknowledged that it would follow the decision within the Eighth Circuit in cases with the exact same facts. The IRS’s nonacquiescence in the decision remains unchanged.

In North Dakota, the Eighth Circuit held that a payment made to a tenured faculty member under North Dakota State University’s early-retirement program was made in exchange for the relinquishment of the tenured faculty member’s contractual and Constitutionally protected tenure rights, rather than as remuneration for services. As support for its decision, it cited Rev. Rul. 58-301, 1958-1 CB 23. However, for the reasons set forth in the earlier AOD, the Service disagrees that North Dakota was analogous to Rev. Rul. 58-301.

Rulings

In Rev. Rul. 58-301, a worker was employed under a written contract providing for five years of employment. During the second year of employment, the worker and firm agreed to cancel the remaining period of the contract. In consideration of the worker’s relinquishment of contract rights, the firm paid the worker a lump sum. The IRS concluded that the lump-sum payment was not wages for FICA and Federal income tax withholding purposes.

However, it modified and superseded Rev. Rul. 58-301 in Rev. Rul. 2004-110, 2004-2 CB 960, which held that an amount paid to an employee as consideration for the cancellation of an employment contract and relinquishment of contract rights was ordinary income and wages for purposes of FICA, FUTA and Federal income tax withholding. Rev. Rul. 2004-110 states that Rev. Rul. 58-301 erred in its analysis, by failing to apply the Code and regulations appropriately to the question of whether the payments made in cancellation of the employment contract were wages. For this reason, Rev. Rul. 58-301 was modified and superseded. However, under the authority of Sec. 7805(b), the Service is applying Rev. Rul. 2004-110 only if the payment is made after Jan. 11, 2005, under facts and circumstances that are substantially the same as in Rev. Rul. 58-301.

Conclusion

The IRS will follow North Dakota State University within the Eighth Circuit only as to cases that have the exact facts as that case and only to the extent that payments were made before Jan. 12, 2005 (i.e., during the period when the Service made relief available to cases falling under Rev. Rul. 58-301). Consistent with the original AOD, the IRS will continue to litigate cases in the Eighth Circuit involving early-retirement payments, but otherwise having different facts from North Dakota State University, regardless of when the payments were made. Moreover, the Service will continue to take the position that early-retirement payments made to tenured professors are remuneration for services subject to FICA taxes in all cases in other circuits.

AOD 2007-001, 1/18/2007

Tax on Emotional Damages Revisited: DC Cir. Vacates Murphy

In Murphy, DC Cir., 8/22/06, the DC Circuit ruled that Sec. 104(a)(2), dealing with the taxation of nonphysical injury awards, was unconstitutional, because it failed to exclude amounts that were not income under the 16th Amendment; see Winkelman and Fonaro, Tax Clinic, “Tax on Emotional Damages Held Unconstitutional: How to Protect Clients in the Short Term,” TTA, December 2006. On Dec. 22, 2006, the court vacated its previous decision and scheduled oral arguments.

While there is no way to tell how the court will ultimately rule, the issues involving the statute of limitations remain. Thus, preserving the rights of taxpayers affected by these decisions is even more important; tax advisers should continue to consider protective refund claims for eligible clients.

Clarifications

In the January 2007 article by Deborah Walker and Stephen Lagarde, “Employee Benefits & Pensions: Current Developments (Part I),” the 2007 amount in the Exhibit, for the “Limit on elective deferrals to Sec. 401(k), 403(b) and 457, etc., plans,” should read, “$15,500,” not “$15,550.”

In the January 2007 News Notes column, the item by Eileen Sherr, “Private Annuity Transactions Shut Down” should read “(until April 17, 2007).”