Revenue Ruling 85-49: Income and RRTA Tax Rules

Revenue Ruling 85-49 provides specific guidance from the Internal Revenue Service on the tax implications of payments made to railroad employees for relinquishing certain job-related rights. This ruling clarifies how these unique payments are treated for both federal income tax and railroad retirement tax purposes. Understanding this distinction is important for affected employees and employers in the railroad industry.

The Scenario Addressed by the Ruling

The ruling examines a situation involving a railroad company and one of its employees. The company made a single, lump-sum payment to the employee. This payment was not for services the employee had performed or would perform in the future. Instead, the payment was consideration for the employee agreeing to give up specific seniority rights associated with their position.

These seniority rights were significant, directly influencing the employee’s job assignments and potentially their long-term career path within the company. By relinquishing these rights, the employee was altering the terms of their employment and giving up a measure of job security and preference that they had earned over time.

Income Tax Treatment of the Payment

The Internal Revenue Service concluded that the lump-sum payment received by the employee must be included in their gross income as ordinary income. This means the payment is taxed at the employee’s regular income tax rates, similar to wages or a salary. The payment is not treated as a capital gain, which often benefits from lower tax rates.

The reasoning behind this determination is that seniority rights are not considered a “capital asset” under the Internal Revenue Code. The IRS views these rights as being directly connected to the employee’s ability to earn future income from their job. Since the payment is a substitute for the wages or salary the employee might have earned by exercising those seniority rights, it is characterized as ordinary income.

Railroad Retirement Tax Act Considerations

The Internal Revenue Service considers a lump-sum payment for relinquishing seniority rights to be “compensation” for Railroad Retirement Tax Act (RRTA) purposes. This means that both the employee and the employer must pay their respective RRTA taxes on the amount. This position is based on the view that such payments are remuneration for services. Because seniority rights are earned through an employee’s service, a payment to give up those rights is fundamentally connected to the employment relationship.