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Argument preview: Show me the stock options?

When Cuba Gooding Jr.’s character shouts “Show me the money!” in “Jerry Maguire,” is he demanding compensation in cash? Or would he be satisfied with payment in stock options? That — more or less — is the central question in Wisconsin Central Ltd. v. United States: whether the word “money,” when used in the context of compensation, extends to remuneration in stock-option form. The Supreme Court’s answer to that question will determine whether the country’s largest railroads receive tax refunds worth many millions of dollars, and it could shed light on the justices’ approach to the interpretation of tax statutes going forward.

The key statutory provision at issue is 26 U.S.C. § 3231(e)(1), which defines “compensation” for purposes of the Railroad Retirement Tax Act. It says that “compensation” means “any form of money remuneration paid to an individual for services rendered as an employee.” That definition matters because railroads and their employees are subject to special taxes on “compensation.” Those taxes go toward funding a retirement program for railroad workers that is separate from — and on average more generous than — Social Security.

Wisconsin Central and the two other petitioners, all wholly owned subsidiaries of Canadian National Railway Co., have been issuing stock options to their employees since the mid-1990s. Each option allows an employee to buy one share of Canadian National stock over the next 10 years for a price equal to its value on the day the option was granted. So, for example, if an employee receives an option today (when Canadian National’s stock price is approximately $75), the employee can buy one share of Canadian National for $75 at any point between now and 2028.

In the Internal Revenue Service’s view, a railroad employee’s gain from exercising a stock option is just another form of compensation. If Canadian National’s stock rises to $85 and the employee exercises her option to buy it for $75, she has made $10 on the transaction. That $10, according to the IRS, should be counted as “compensation” for purposes of the railroad retirement tax.

The nation’s largest private-sector railroads all disagree with the IRS’s view, and so they sued for tax refunds in various courts. The U.S. Court of Appeals for the 5th Circuit rejected BNSF Railway’s refund claim in 2015, deferring to the IRS’s position that the exercise of stock options falls within the statute’s definition of “compensation.” A district court in Florida came out the same way last March in a case brought by CSX. And Wisconsin Central and its fellow Canadian National subsidiaries struck out at the U.S. Court of Appeals for the 7th Circuit last May, with Judge Richard Posner writing a pithy opinion for a 2-1 majority.

But less than four weeks after the 7th Circuit’s Wisconsin Central decision, the U.S. Court of Appeals for the 8th Circuit sided with Union Pacific Railroad on virtually identical facts, holding that stock-option income is not taxable under the RRTA. The railroads and the federal government both asked the Supreme Court to take up the Wisconsin Central case in order to resolve the split, and the court granted cert earlier this year. Incidentally, this may be the last time that the Supreme Court reviews a decision written by Posner, who stepped down from the 7th Circuit this past September.

In its opening brief, Wisconsin Central seeks to frame the case as hinging upon the “plain meaning” of a single word: “money.” It’s “common sense,” says Wisconsin Central, that “stock is not money.” And sometimes that’s so. If a robber waved a knife at you and said “give me all your money,” you would probably think — if you had time to think — that she was demanding that you hand over the cash in your wallet, not that you transfer ownership of any stock you might hold in an E-Trade account. Likewise, when Steve Miller sings “take the money and run,” he is not advising the bandits to abscond with stock certificates. Money means cash.

But in other circumstances, “money” takes on a broader significance. Who makes more money — American Airlines CEO Doug Parker or me? Parker, of course: His total compensation in fiscal year 2016 exceeded $11 million, and my salary as an assistant professor was nowhere close. Parker’s pay comes almost entirely in stock — in fact, his total cash compensation in fiscal year 2016 was zero, and mine was greater than zero — but still, virtually everyone would agree that Parker made more “money” than I did. Likewise, when the Notorious B.I.G. raps “Mo Money Mo Problems,” he presumably is referring to the challenges of wealth (including stock-based wealth), and not just the difficulties arising from large cash holdings. The meaning of “money” changes with the context.

Wisconsin Central goes on to argue that the broader context of the Internal Revenue Code supports its view that stock is not “money.” In other tax provisions, Congress has distinguished between “stock” and “money.” Wisconsin Central also points to the language of the Federal Insurance Contributions Act, enacted around the same time as the RRTA, which covers most other employers and employees but specifically exempts railroads and railroad workers. FICA taxes apply to “wages,” which are defined to encompass “all remuneration for employment,” and all parties agree that FICA’s definition encompasses stock options. The contrast between the phrase “all remuneration” in FICA and “money remuneration” in the RRTA is evidence, according to Wisconsin Central, that Congress intended the railroad tax to fall on a narrower base.

The United States’ contextual argument is almost the polar opposite of Wisconsin Central’s: The fact that FICA covers income from the exercise of stock options, according to the government, is precisely why the railroad tax law should be construed to do the same. Over the years, Congress has inserted a number of parallel exemptions into FICA and the RRTA — evidently in an attempt to ensure that the bases for the two taxes converge. According to the United States, the similar structures of FICA and the railroad-tax law suggest that the two statutes should be interpreted to reach the same result. Moreover, Congress has specifically exempted a particular type of stock options — called “incentive stock options” — from taxation under both FICA and the RRTA. That, says the United States, suggests that Wisconsin Central’s stock options, which aren’t “incentive stock options,” should be subject to tax under both regimes.

The United States closes its brief with an argument that is likely to draw the attention of tax practitioners, although it probably won’t be the point on which the Supreme Court’s decision turns. The government cites a 1994 Treasury Department regulation that provides that “[t]he term compensation [in the RRTA] has the same meaning as the term wages in [FICA] … , except as specifically limited by the Railroad Retirement Tax Act.” The government says that “deference principles” therefore weigh in favor of treating stock options as compensation under the RRTA.

This was the argument that swayed the 5th Circuit in the BNSF case and the Florida district court in the CSX case, both of which explicitly followed the two-step deference framework of Chevron, U.S.A. v. Natural Resources Defense Council to resolve the same issue in the government’s favor. Under the Chevron framework, a court must first determine whether a statute is ambiguous; if so, the court should defer to an administrative agency’s reasonable interpretation. The 5th Circuit and the Florida district court both said that “money remuneration” could have multiple meanings and that the IRS’s reasonable interpretation should prevail under Chevron. Yet the government now mentions Chevron almost as an afterthought. Indeed, although it says that deference principles “support” its position, the government never explicitly asks for Chevron deference to the 1994 Treasury regulation.

It’s now been more than seven years since the Supreme Court, in a case called Mayo Foundation for Medical Education & Research v. United States, held that “Chevron appl[ies] with full force in the tax context.” But each time that the government has asked the court for Chevron deference in a tax case since Mayo, it has been rebuffed. This might be a function of Chevron’s falling stature as much as it is a tax-specific phenomenon. But because it’s relatively rare for a case involving a Treasury tax regulation to reach the Supreme Court, each time the court weighs in on the subject (or says nothing about a Chevron argument in a tax case), it sends ripples through the tax controversy community.

Ultimately, the primary impact of the Supreme Court’s decision in Wisconsin Central will likely be limited to the nation’s largest private-sector railroads and their employees. A potential refund of approximately $13 million is at stake in this case for the petitioners and their employees; a refund of roughly $55 million rides on an identical question in the 6th Circuit Union Pacific case, which is the subject of a pending cert petition; and another $2 million is at issue in the CSX suit. For Union Pacific’s CEO, whose equity compensation topped $7 million in fiscal year 2016, the impact on his personal fortune will probably be in the six figures. To be sure, the railroads and their well-compensated executives almost certainly will do just fine whichever way the justices come down. Still, that’s a lot of money — however you define it.

Recommended Citation: Daniel Hemel, Argument preview: Show me the stock options?, SCOTUSblog (Apr. 9, 2018, 10:18 AM),