Revenue Ruling 82-33: Tax Treatment of Payments
This analysis of Revenue Ruling 82-33 clarifies why lump-sum payments for job rights are treated as ordinary income rather than a capital gain.
The Internal Revenue Service (IRS) issues Revenue Rulings to provide official interpretations of tax law for taxpayers and IRS personnel. These rulings establish precedents for specific situations, including the tax consequences for employees who receive payments for relinquishing rights connected to their employment. This guidance clarifies how such payments are classified, which directly impacts an employee’s tax liability.
Payments for Relinquishing Seniority Rights
A scenario addressed by IRS guidance involves railroad employees who receive a lump-sum payment from their employer for giving up their seniority rights. These rights are an aspect of employment in the railroad industry, often governing job security and work-life quality.
Seniority rights in the railroad industry provide employees with preferential treatment in various aspects of their job. This can include priority in selecting job assignments, choosing more desirable work shifts, and gaining protection from layoffs. When a railroad company offers a payment to an employee to surrender these accrued rights, the tax treatment of that payment becomes the central issue.
Tax Characterization of Payments
The IRS has determined that a payment received for giving up seniority rights constitutes ordinary income. This classification is distinct from a capital gain, a difference that has financial implications for the taxpayer. The distinction is based on the nature of the right being relinquished.
Tax law differentiates between ordinary income from wages and capital gains from the sale of an asset like stocks or real estate. Long-term capital gains are taxed at lower rates than ordinary income. The IRS concludes that seniority rights do not qualify as a capital asset because these rights are linked to the future performance of services, not a property investment. The payment for them is considered a substitute for future wages, classifying it as ordinary income.
Based on guidance in Revenue Ruling 75-44, while these payments are ordinary income, they are not considered “compensation” for purposes of the Railroad Retirement Tax Act (RRTA).
How to Report on Your Tax Return
An employer should report a payment for relinquished seniority rights on Form 1099-MISC, Miscellaneous Information, in Box 3 as “Other Income.” Because the payment is not subject to Railroad Retirement Tax Act (RRTA) taxes, it should not be on a Form W-2. If your employer incorrectly reports the payment on a Form W-2, you should request a corrected Form W-2c and a separate Form 1099-MISC.
The recipient must report the amount shown on the Form 1099-MISC as income on their Form 1040, U.S. Individual Income Tax Return. This payment is reported on Schedule 1 (Form 1040), Additional Income and Adjustments to Income, under the “Other income” line. The full amount is subject to the taxpayer’s regular marginal income tax rate and is not eligible for the preferential tax rates associated with long-term capital gains.