Railroad Workers’ Recovery of Lost Earnings Are Now Taxable Under the RRTA

Railroad workers who successfully sued their employers for lost wages under the Federal Employers’ Liability Act (FELA) used to be able to retain the full amount of those recoveries assigned for lost wages without paying taxes under the Railroad Retirement Tax Act (RRTA). After a recent United States Supreme Court opinion, however, railroad workers may be seeing smaller settlements or decreased lost wages awards under the FELA.

In Burlington Northern Santa Fe Railway Co. v. Loos, Loos sued his employer under the FELA after he was injured in the railyard and was out of work during his recovery. Under the FELA, railroads are liable to their employees for any injuries the employees sustain due to the railroad’s negligence. Burlington Northern was found liable since Loos was able to show that Burlington Northern had failed to address a hidden drainage grate that caused him to fall and injure his knee. The jury awarded him a $126,212.78 verdict for medical expenses, pain and suffering, and lost wages. The jury allocated $30,000 of the award to lost wages. Of this amount, the railway asserted that it needed to retain $3,756 for tax purposes under the RRTA.

The RRTA operates as the funding arm of a self-sustaining pension and benefit fund system for railroad workers. It enables the Internal Revenue Service (IRS) to collect a payroll tax from both railroads and their employees based on the amount of compensation an employee earns. The railroad’s portion is considered an excise tax and the employee’s portion is considered an income tax. To determine an employee’s compensation, the IRS does not consider certain types of sick pay and disability pay. The IRS does, however, consider wages for time when the employee is absent from active service at work within the definition of compensation.

The Supreme Court in Loos agreed with the IRS that despite Loos’ absence from active service to earn his lost wages award, he had still received the funds in connection with an employer-employee relationship, so they were thus subject to tax under the RRTA as if he had earned them through active service for the railroad. Since Loos’ award under the FELA was functionally equivalent to backpay, which is considered compensation for RRTA purposes, Loos’ award was subject to the RRTA tax.

Under the Loos case, employee wage awards granted under the FELA are not the only item subject to the RRTA tax. Railroads themselves are now also responsible for paying the excise portion of the RRTA tax on amounts paid to employees for lost wages under the FELA. This shift in tax liability for judgment awards also shifts the negotiation power and incentives for settlement before trial. Since railroads and employees alike may want to avoid paying the RRTA taxes on portions of settlements allocated to lost wages, there may be more incentive to settle a case rather than taking it to trial since juries tend to give more generous awards for lost wages.

The effective result is that railroads may be able to offer lower settlement figures in exchange for allocating a smaller percentage (or none) of the award to now RRTA taxable lost wages. This would allow for plaintiffs to retain, untaxed, more of their verdicts since the other portions of an award under the FELA are not subject to RRTA tax (medical expenses and pain and suffering). Employees may start pushing harder for these items in settlement negotiations or during trials to recover the portions of lost wages now allocated to RRTA tax. Railroads, thus, should be aware of the consequences when determining what portion of disability settlements under the FELA should be attributed to lost wages and how the negotiation process will shift using different allocations.

This article was written with contribution from Sarah Rothermel, 3rd year law student at Widener Law Commonwealth.

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