Excise Tax – Stock Options

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7^th Circuit Court of Appeals

Case Name: Wisconsin Central Ltd., et al v. United States of America

Case No.: 16-3300, 16-3303; 16-3304

Officials: POSNER, MANION, and HAMILTON, Circuit Judges.

Focus: Excise Tax – Stock Options

Beginning in 1996, the plaintiff‐ appellants, subsidiaries of the Canadian National Railway Company (to simplify we’ll refer to the subsidiaries as “the railway”), began including stock options in the compensation plans of a number of employees. In this suit against the government, the railway argues that income from the exercise of stock options that a railroad gives its employees is not form of “money remuneration” to them and is therefore not taxable to the railway as compensation under the Rail‐ road Retirement Tax Act, 26 U.S.C. § 3231(e)(1), which de‐ fines “compensation” as “any form of money remuneration paid to an individual for services rendered as an employee to one or more employers.” See also BNSF Railway Co. v. United States, 775 F.3d 743 (5th Cir. 2015).  As explained in Standard Office Building Corp. v. United States, 819 F.2d 1371, 1373 (7th Cir. 1987), “the Railroad Retirement Tax Act, passed in 1937, is to the railroad industry what the Social Security Act is to other industries: the imposition of an employment or payroll tax on both the employer and the employee, with the proceeds used to pay pensions and other benefits. … The Act requires the railroad to pay an excise tax equal to a specified percentage of its employees’ wages, and also to withhold a specified percentage of its employees’ wages as their share of the tax. The railroad retirement tax rates are much higher than the social security tax rates.” The question presented by this case is whether the excise tax should be levied not only on employees’ wages but also on the value of stock options exercised by employees who, having received the options from their employer, exercise them when the market price exceeds the “strike price” (the price at which the employee has a right to buy the stock) and thus obtain the stock at a favorable price. The Internal Revenue Service answers yes, see 26 C.F.R. § 31.3231(e)‐1, and the district court agreed, precipitating this appeal.

Affirmed

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Attorney Derek A. Hawkins is the managing partner at Hawkins Law Offices LLC, where he heads up the firm’s startup law practice. He specializes in business formation, corporate governance, intellectual property protection, private equity and venture capital funding and mergers & acquisitions. Check out the website at www.hawkins-lawoffices.com or contact them at 262-737-8825.