The Federal Circuit held that taxpayers could not receive a refund of Federal Insurance Contributions Act (FICA) tax paid on retirement benefits that would never be received due to the employer's obligation to pay the benefits having been discharged in bankruptcy.
Facts: Louis Balestra, a retired United Airlines pilot, was eligible to receive retirement benefits for the rest of his life under a nonqualified deferred compensation plan, and he elected to begin receiving those benefits on the day he retired in 2004. The present value of the deferred compensation was determined to be $289,601, and United withheld the applicable Medicare tax portion of FICA, 1.45% of that amount, or $4,199.
United had filed for bankruptcy in 2002, and its obligation to pay the benefits was eventually discharged. As a result, United stopped paying benefits to Balestra in 2010, after having paid only $63,032 in retirement benefits. Balestra and his wife, on a joint return, sought a refund of $3,285, which represented the amount of FICA withheld and paid in 2004 that related to benefits they would never receive due to United's bankruptcy. The IRS denied their claim, and the Balestras filed an action in the Court of Federal Claims, which granted the government's motion for summary judgment (Balestra, 119 Fed. Cl. 109 (2014)). The Balestras appealed to the Federal Circuit.
Issues: FICA tax is imposed on wages, which are defined in Sec. 3121(a) to include deferred compensation. Unlike typical wages, which are treated as received by the employee when they are paid by the employer, wages that result from a nonqualified deferred compensation plan are subject to a special timing rule. Congress provided that any "amount deferred" under a nonqualified deferred compensation plan shall be taken into account as of the later of the date when the services are performed or when there is no substantial risk of forfeiture. In Regs. Sec. 31.3121(v)(2)-1(c)(2)(i), Treasury defined "amount deferred" by reference to the present value of the deferred compensation. The regulation also states that "present value cannot be discounted for the probability that payments will not be made ... [because the employer] will be unwilling or unable to pay" (Regs. Sec. 31.3121(v)(2)-1(c)(2)(ii)).
The Balestras claimed before the Court of Federal Claims and again before the Federal Circuit that Regs. Sec. 31.3121(v)(2)-1(c)(2)(ii) is invalid under Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), and Motor Vehicle Manufacturers Ass'n of the United States v. State Farm Mutual Automobile Ins. Co., 463 U.S. 29 (1983). Specifically, the Balestras claimed the regulation did not apply to them because United was already in bankruptcy when the present value of the deferred compensation was determined. They also claimed the regulation's definition of "amount deferred," which turns on present value, is arbitrary and capricious.
Holding: The Federal Circuit found that having not provided a definition of "amount deferred," Congress was silent on the question at issue, and Treasury's definition based on present value considers reasonable actuarial assumptions. Further, Treasury and the IRS were not legally obligated to include the contingency that, if an employer became bankrupt, an adjustment in tax would be made. Rather, Treasury and the IRS had sought simple, workable, and flexible rules for valuing future benefits, and the fact that those rules may result in unfair results in certain instances does not render them invalid.
Accordingly, the Federal Circuit affirmed the decision of the Court of Federal Claims.
- Balestra, No. 14-5127 (Fed. Cir. 10/13/15)
—By Laura Lee Mannino, CPA, LL.M., associate professor of accounting and taxation, St. John's University, Queens, N.Y.