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Opinion analysis: Railroads as the new tax shelter?

Berkshire Hathaway CEO Warren Buffett has long lamented the fact that he pays a lower tax rate than his secretary. Now, top executives at Berkshire Hathaway-owned BNSF railroad will pay an even lower rate than their counterparts elsewhere.

That is the outcome of the Supreme Court’s 5-4 ruling in Wisconsin Central Ltd. v. United States, which holds that railroad employees are exempt from federal employment taxes on stock-based compensation. The decision delivers a victory for Wisconsin Central and its parent company, Canadian National Railway, which stand to reap a $13 million refund as a result of the ruling, as well as for other large railroads such as BNSF. It’s a setback for the Internal Revenue Service, opening up a new loophole for taxpayers to exploit. And perhaps most significantly, it’s another triumph for a textualist mode of statutory interpretation that prioritizes dictionary definitions over practical consequences.

The statute at issue, the Railroad Retirement Tax Act of 1937, may be unfamiliar to most readers, but several elements of it closely parallel the federal employment tax regime for non-railroad employers and employees. The RRTA levies a 6.2 percent employer- and employee-side “Tier 1” tax up to a wage cap of $128,400, which matches the 6.2 percent employer- and employee-side tax on non-railroad payrolls under the Federal Insurance Contributions Act. The RRTA further imposes a 1.45 percent employer- and employee-side Medicare tax that matches the Medicare tax on non-railroad employers and their workers. And the RRTA adds an 0.9 percent tax on individuals earning over $200,000 and married taxpayers earning more than $250,000, which mirrors the additional 0.9 percent tax on other high-income employees under the Affordable Care Act. (A separate “Tier 2” tax with a much lower wage cap finances additional retirement benefits for railroad employees.)

The question in Wisconsin Central was whether taxes under the RRTA — which generally apply at the same rate as other federal employment taxes — also apply to the same base. The RRTA applies to “compensation,” which is defined to mean “any form of money remuneration.” The Federal Insurance Contributions Act applies to “wages,” which are defined to mean “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” The latter statute has been understood for decades to apply to stock-based compensation. The dispute in Wisconsin Central was whether the RRTA does too.

In a crisp nine-and-a-half page opinion joined by his four conservative colleagues, Justice Neil Gorsuch answers that question in the negative. His primary argument is that dictionaries and court cases circa 1937 considered “money” to mean “a medium of exchange.” “Pretty obviously,” writes Gorsuch, “stock options do not fall within that definition,” adding that “few of us buy groceries or pay rent or value goods and services in terms of stock.” To be sure, as the dissent notes, few of us buy groceries by endorsing our paychecks over to the supermarket — instead, we deposit our paychecks in the bank and then withdraw funds. So too, we can convert stock options into groceries in a matter of minutes with an E-Trade account and a credit card. But “stock,” says the majority, is not “money,” even though paychecks “no doubt” are.

Gorsuch also points to various places in the 1939 Internal Revenue Code where “stock” is mentioned in contradistinction to “money.” He further emphasizes the difference in language between the RRTA and the Federal Insurance Contributions Act, noting that “[w]e usually presume differences in language like this convey differences in meaning.” And he cites a regulation promulgated by the IRS predecessor agency in 1938 explaining that the RRTA applies to “something which may be used in lieu of money.” Stock options, according to Gorsuch, do not serve that function.

Nowhere, though, does Gorsuch explain why Congress would want railroads and their executives to be exempt from Medicare taxes on stock-based pay. (As a practical matter, today’s decision will matter mostly for Medicare-tax purposes, because railroad employees with generous stock-option packages will probably hit the Tier 1 and Tier 2 wage caps based on their cash compensation alone.) Justice Stephen Breyer, in dissent, hammers the majority on that point: Why should different tax rates apply to employees who receive the same amount of money in their bank accounts “simply because one received a paycheck while the other received proceeds from selling company stock”? Indeed, as Breyer notes, roughly half of the Wisconsin Central employees who receive stock-option pay choose to “check a box on a form” that instructs the employer to exercise their options immediately and then deposit the proceeds into their bank account — “just like a deposited paycheck.”

And the statute, according to Breyer, does not command this anomalous result. Dictionaries at the time of the RRTA actually offered a wide range of definitions of “money,” some of which likely would encompass stock options. The legislative history of the RRTA suggests that Congress used the language that it did in 1937 to ensure that free transportation and other in-kind benefits would be excluded from employment tax — not to carve out stock or stock options. Congress also has amended both the RRTA and the Federal Insurance Contributions Act to exempt a particular type of stock option — “incentive stock options” — which are separate from the stock options at issue here. “[W]hat need would there be to do so,” Justice Breyer asks, “if all noncash benefits, including stock options, were already excluded?”

Breyer ends his dissent by suggesting that the Supreme Court should defer to the IRS’s view that the RRTA covers stock-based pay. Adopting the agency’s interpretation, according to Breyer, would avoid the “unfairness” that today’s result generates. On a day when Justice Anthony Kennedy wrote separately in another case to criticize the federal courts of appeals for deferring to agency interpretations too often, it is no surprise that the majority declined to take up Breyer’s suggestion.

What might today’s decision mean for the tax system going forward? It is no doubt the second-most important tax decision of the day: The decision handed down moments later in South Dakota v. Wayfair will have an impact that is many orders of magnitude greater. Railroads, after all, are a very small sector of the American economy in 2018, and an exemption from employment taxes for a sliver of railroad-employee pay won’t seriously erode the federal tax base. But the decision does open up a potentially attractive arbitrage opportunity for at least a few tax-savvy enterprises. The statutory definition of a railroad “employer” is broad: Any company “under common control” with a rail carrier that operates any rail-related business potentially can qualify. A non-railroad enterprise could choose to merge with a railroad and potentially avoid employment taxes on its executives’ stock-option pay. Buffett’s Berkshire Hathaway, which already owns a railroad, would seem to be especially well positioned to implement this strategy. Might railroads — the big business of yesterday — be the tax shelters of tomorrow? That’s not a prediction, but it’s the sort of question that crops up when formalism reigns in federal tax law.

Recommended Citation: Daniel Hemel, Opinion analysis: Railroads as the new tax shelter?, SCOTUSblog (Jun. 21, 2018, 5:29 PM),