The Third Circuit Court of Appeals recently held that payments to tenured faculty and administrators at the University of Pittsburgh who relinquished tenure rights under an early-retirement plan were subject to FICA taxes. The ruling was contrary to an Eighth Circuit case with similar facts ( North Dakota State University v. U.S. , 87 AFTR2d 2001-2522).
The Third Circuit, in a split decision that overturned a district court ruling, held that tenure, although awarded on a limited and discretionary basis, was based on past service to the university and was a form of compensation for that service. Therefore, and because the employees’ relinquishment of tenure rights was not the primary consideration given by them, the payments represented wages for purposes of FICA, the court said.
Any cash or noncash remuneration received for employment, unless exempted by law or regulation, is considered wages subject to Federal Insurance Contribution Act taxes, which support Social Security and Medicare. The Eighth Circuit in North Dakota State University based its decision on the holding of Revenue Ruling 58-301, 1958-1 C.B. 23, that a lump-sum payment to cancel an employee’s contract rights was not FICA wages. The IRS in 2002 declined to acquiesce to North Dakota State University, stating its belief that the payments arose out of the employer-employee relationship and were made as a consequence of past services performed by the professors that resulted in their tenure. Furthermore, in 2004 the IRS issued Revenue Ruling 2004-110, 2004-2 C.B. 960, which held that payments after Jan. 11, 2005, to cancel an employment contract and relinquish contract rights are subject to FICA.
Between 1982 and 1999, the University of Pittsburgh offered early-retirement plans to tenured professors and administrators. The plans had a minimum age requirement and required a minimum number of years of service to the university. Plan participants would receive monthly payments if they relinquished their tenure rights. Between 1996 and 2001, the university paid more than $2 million in FICA taxes on the payments. Later, the university attempted to recover the taxes in a district court action. The district court held, based on Revenue Ruling 58-301, that the payments were made in exchange for contractual rights and thus were not wages subject to FICA taxes.
In its appeal to the Third Circuit, the IRS argued for following the holding of the Sixth Circuit in Donald F. Appoloni et al. v. U.S., 97 AFTR2d 2006-2828. That opinion concluded that payments to public school teachers who gave up their tenure rights under an early-retirement plan were wages for FICA. After examining the terms of the Pitt retirement plans, the Third Circuit agreed. The plans linked eligibility to past service and had a stated purpose of maintaining a competitive compensation package by offering early-retirement incentives. The court also likened the payments to severance payments, which previously have been held to be FICA wages.
In a dissenting opinion, Chief Judge Anthony Joseph Scirica agreed with the university that the payments were given in exchange for property rights (tenure). Tenure at Pittsburgh is not automatically granted after a certain number of years of worthy service but is also based on other factors, such as personnel needs, financial resource constraints and curricular needs, he noted. In addition, the granting of tenure marks the beginning of a new contractual relationship, not a continuation of the old, distinguishing it from severance payments, Scirica wrote.
The decision further muddies the water on this issue. It remains unclear what impact Revenue Ruling 2004-110 might have on similar situations, since it applies to payments made after those of this case.
University of Pittsburgh v. U.S. , 100 AFTR2d 2007-6504
Prepared by Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.