The Seventh Circuit affirmed a district court’s ruling that FICA must be withheld on contributions made by salary reduction to a section 403(b) retirement plan. The circuit also affirmed the trial court’s upholding of a penalty for failing to deposit the taxes.
The University of Chicago made contributions to purchase nontransferable annuity contracts, and its employees contributed to a section 403(b) plan. The employees were required to contribute a portion of their salary after signing a salary reduction agreement.
From 2000 through 2003, the university did not withhold or pay FICA on the amounts withheld from the employees’ salaries or on the university’s additional contributions to purchase the annuities. The IRS assessed unpaid employment taxes, failure-to-deposit penalties and interest for all the years in question. The university sought relief from the U.S. District Court for the Northern District of Illinois, which held for the IRS.
The IRS relied on IRC § 3121(a)(5)(D), which excludes from wages any payments made to or on behalf of an employee or beneficiary under a section 403(b) plan but includes such payments in wages if they are “made by reason of” a salary reduction agreement. The agreement need not be in writing. Because the university’s payments were made by reason of a salary reduction agreement, the IRS argued, they were subject to FICA withholding and payment.
The university emphasized the word “agreement” in the Code provision, arguing that because its employees had no choice in the matter, it didn’t apply to them, only to payments pursuant to individually negotiated agreements.
The district court agreed with the IRS, rejecting the university’s contention that the language is ambiguous. If Congress had intended the provision to apply only to individually negotiated salary reduction agreements, it would have added those words, the court said.
Before the Seventh Circuit, the university again argued that the intent of the language of section 3121(a)(5)(D) was to include only amounts from voluntary salary reduction agreements. Based on a plain reading of the section, revenue rulings, regulations and the history of the application of the section, however, the court upheld the district court’s finding.
The university also argued that the failure-to-pay penalty should not be imposed because it subjected taxpayers to substantial penalties for challenging an assessment. It argued further that the interest due on the unpaid taxes was an adequate penalty for a reasonable challenge to the application of a statute. The circuit court held that failure-to-pay penalties were properly imposed as allowed under section 6651(a)(3) unless the nonpayment was due to reasonable cause and not willful neglect.
n University of Chicago v. U.S.,102 AFTR2d 2008-5487
By Karyn Bybee Friske, CPA, Ph.D., Pickens Professor of Business and associate professor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.