Russell L. Anderson, Joseph J. Beer, Gerald L. Begeman, Kathryn G. Blessing, Marion Branick, Patrick Brew, James Cullop, Janet v. Driscol, Roberta Anne Eddy, Ann J. Gasparini, Susan Lynn Greiner, Leroy W. Hasselbring, Leon E. Pohlman, Wanda Jo Raper, Sandra Katherine Sandona, Robert E. Thompson, Frances Wyand, and Victoria Youngblood v. The United States

Citation: 929 F.2d 648Docket: 90-5002

Court: Court of Appeals for the Federal Circuit; March 20, 1991; Federal Appellate Court

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The United States Court of Appeals for the Federal Circuit reviewed an appeal by the United States concerning a judgment from the United States Claims Court, which awarded tax refunds to Department of Defense civilian employees for FICA taxes withheld from 1984 to 1987. The Claims Court determined that certain payments for living quarters and temporary lodging, made under the Overseas Differentials and Allowances Act (ODAA), were exempt from FICA taxation. The United States conceded that no FICA taxes were applicable to ODAA payments for 1984 but contested the taxation of these payments for 1985-1987, specifically questioning whether amendments made by the Deficit Reduction Act (DRA) subjected these previously nontaxable payments to FICA. The court affirmed the Claims Court's ruling, concluding that the DRA did not alter the nontaxable status of the living quarters and temporary lodging allowances. Plaintiffs, who were teachers at the United States Naval Air Station in Bermuda, received living quarters allowances (LQA) and temporary lodging allowances (TLA) for housing costs incurred while working overseas, with specific regulations governing these payments established by the Department of State. These allowances have been in place in various forms since at least 1930.

ODAA allowances are explicitly excluded from 'gross income' and exempt from income tax under 26 U.S.C. Sec. 912(1)(C). The Social Security Act introduced FICA taxes on employee wages to fund social security benefits, with government wages previously exempt until January 1, 1984, when FICA was extended to certain government employees. The Navy began including ODAA payments in the FICA tax base retroactively in June 1984, without accounting for government housing value. In contrast, the State Department continued to treat ODAA as nontaxable under both FICA and income tax codes.

An amendment in 1983 decoupled the definitions of 'wages' for FICA and income tax, allowing different exclusions, yet no regulations were issued to implement this change. The Claims Court initially focused on the 1983 amendments to justify FICA tax collection for ODAA payments, but the government later acknowledged these amendments did not impose FICA taxes on ODAA. The government now relies on changes made by the DRA to subject ODAA payments to FICA taxes from 1985 onwards.

The analysis begins with the 1984 FICA provisions, where ODAA payments were not taxable, and proceeds to the 1985 provisions claimed by the government to have altered this status. In 1984, 'wages' for FICA were broadly defined as all remuneration for employment, while 'income' remains a broader term, indicating that 'wages' is a subset of 'income' in the tax code context.

The excerpt outlines the legal interpretation of the Old Age, Disability, and Survivors Insurance (ODAA) payments in relation to Federal Insurance Contributions Act (FICA) taxes and income tax regulations. 

1. **FICA Exclusions**: The definition in 26 U.S.C. § 3121(a) includes 19 specific exceptions to FICA taxation, such as certain disability payments and non-cash tips. The exclusion of ODAA payments from FICA taxes in 1984 did not derive from these exceptions, as the government later claimed ODAA payments became taxable in 1985.

2. **Claims Court Ruling**: The Claims Court rejected the government's assertion that ODAA payments constituted 'compensation for services' or 'remuneration for employment' under the 1984 statute. Consequently, ODAA payments were not classified as 'wages' under FICA or as 'income' under the income tax statute in 1984.

3. **Legislative Intent**: The court emphasized that the legislative history of the ODAA indicated these payments were intended solely as reimbursements for additional expenses incurred by federal employees assigned overseas, not as part of compensation for tax purposes. An explicit exclusion from 'gross income' was included in section 912(1).

4. **Deficit Reduction Act of 1984**: The DRA, effective January 1, 1985, brought significant reforms to the income tax code regarding fringe benefits, while the amendments to FICA were described as 'conforming' and did not mention ODAA payments. The government's argument that ODAA payments were implicitly subjected to FICA taxes after the DRA is deemed unreasonable.

5. **Conclusion on ODAA Taxability**: The DRA did not alter the tax treatment of ODAA payments, which remained excluded from both income tax and FICA taxation. Historical IRS rulings prior to 1984 supported the exclusion of certain employee benefits from FICA taxation, and the 1984 Act established a new framework for taxing fringe benefits, superseding earlier administrative practices.

Section 61(a)(1) of the Code defines 'gross income' for income tax purposes to include 'compensation for services,' which has been amended by the DRA to broadly encompass 'fringe benefits.' Concurrently, a new section 132 was introduced to exclude certain 'fringe benefits' from 'gross income.' The 1984 Act also revised income tax withholding rules, clarifying that benefits are taxable even if not received in cash. The definition of 'wages' in section 3401(a) was updated to include benefits, establishing that amounts paid as 'fringe benefits' after December 31, 1984, are subject to income tax unless specifically excluded. Notably, ODAA payments are exempt from gross income under section 912(1)(C) and not under section 132, making the question of whether they qualify as 'compensation for services' irrelevant, as they are not considered 'wages' for withholding purposes. The DRA made few alterations to FICA tax provisions, maintaining the original language in section 3101, while section 3121(a) was amended to encompass all remuneration, including benefits. However, the government’s assertion that the phrase 'including benefits' subjects ODAA payments to FICA taxation is disputed, as it merely clarifies the treatment of non-cash fringe benefits.

The amendment to the definition of 'wages' under FICA aligns with similar changes in the income tax code, specifically section 3401, aiming for consistency between the two. The taxation of 'fringe benefits' stems from the DRA's modification of the 'gross income' definition in section 61(a), not from the inclusion of 'benefits' in section 3401(a). Therefore, the amendment in section 3121(a) does not convert non-income ODAA payments into taxable 'income' under FICA. The government’s reliance on the income tax code, particularly section 61(a)(1), to classify 'fringe benefits' as taxable under both FICA and income tax is flawed because 'fringe benefits' were included in 'gross income', while ODAA payments have consistently been excluded from this definition since 1960 through section 912(1)(C). The addition of section 132, which excludes certain fringe benefits from 'gross income', does not alter the non-income status of ODAA payments for FICA purposes. Consequently, ODAA payments cannot be classified as 'wages' under FICA, confirming that they remain exempt from FICA taxes. This conclusion is consistent with the legislative history that states amounts exempt from income tax withholding should also remain exempt from FICA unless explicitly stated by Congress. The court affirms the judgment, maintaining that ODAA payments are not subject to FICA taxes.

Section 912(1) specifies items that are exempt from gross income and taxation, particularly foreign area allowances received by civilian U.S. government employees. These allowances are outlined in various legislative acts, including the Foreign Service Act of 1980, the CIA Act of 1949, and the Overseas Differentials and Allowances Act. The provisions were reenacted under the Federal Insurance Contributions Act (FICA) in 1954, responding to the Supreme Court's decision in Rowan Cos. Inc. v. United States, which mandated a consistent interpretation of 'wages' for FICA taxes and income tax withholding. The Claims Court's opinion did not depend on this provision, focusing instead on the narrower argument that these exemptions apply under FICA due to the 1985 statute's structure post-DRA amendments. Furthermore, the definition of gross income under IRC section 61(a)(1) includes compensation for services, while various fringe benefits are outlined under section 132. Section 3401(a) defines 'wages' broadly, encompassing all forms of remuneration for services, excluding fees to public officials. The legislative response to Rowan Cos. reinforces that the interpretation of 'including benefits' should be consistent across both FICA and income tax withholding statutes, with no differing regulatory implications indicated.