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Railroad Industry Overview Series - Significant Law and Important Issues

LMSB Control Number: LMSB-04-1007-072
Affected IRM: X.XX.X

This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited or relied upon as such.

Significant Law and Important Issues

A. Coordinated Issues

Issue

Brief Summary of Issue

None for this Technical Area

.

B. Emergining or Other Significant Issues

Issue

Brief Summary of Issue

Track Maintenance

Whether amounts spent on annual track program maintenance, generally paid from railroad Capital Budgets, are capital improvements for tax purposes.

Revenue Procedures 2002-65, for Class II and III railroads, and 2001-46, for Class I’s, provide safe harbor methods to determine whether track expenditures are currently deductible or capital expenditures. Most of the major railroads have adopted these methods.

Like-Kind Exchanges of Track Property

TAM 200424001 outlines the proper interpretation of Section 1031 with respect to exchanges involving track property, including whether line segments qualify as like-kind for uninstalled components; determination of track as real vs. personal property, and treatment of Section 1031 required basis adjustments under Revenue Procedure 2001-46..

Cyclical Overhauls of Locomotives

Railroads periodically overhaul locomotive engines, in many instances, contemporaneously with overhauls/replacements/maintenance of other locomotive parts. The expenditures are capital if they were paid or incurred to add to the value, or substantially prolong the useful life, of the locomotive or to adapt the locomotive to a new or different use. Treas. Reg. Sec. 1.263(a)-1(b). If the expenditures neither materially add to the locomotive's value nor appreciably prolong its useful life, but keep it in an ordinarily efficient operating condition, they are incidental repairs. Treas. Reg. Sec. 1.162-4. Revenue Ruling 2001-04 applies to these expenditures. .

Donations and Bargain Sales of Railway Rights-of-Way.

Railroads claim charitable contribution deductions for contributions or bargain sales of rights-of-way, often for trail use under the Rails to Trails Act, 16 U.S.C. Sec. 1247(d).  In many instances, the taxpayers own only an easement subject to termination on cessation of rail use rather than a fee simple interest in all or part of the donated property. TAM 2006100017 states that if these transfers otherwise satisfied the requirements of IRC 170, the transfers would constitute deductible charitable contributions, only if the possibility that the property will revert to the taxpayer or its assigns is remote under Income Tax Regulations § 1.170A-7(a)(3). The determination of remoteness is factual for each conveyance.

Property Received from Users of Rights-of-Way for Fiber Optics Cables

 

 

 

Railroads enter into bartering transactions with telecommunications companies where, in exchange for use of their right of way, they receive income in the form of property, such as fiber optic strands, equity interest in the telecom company, etc.  Generally, gain on the exchange of property for another property is included in income for tax purposes. In a typical exchange, the taxable gain will be the excess of the value of the asset transferred to the taxpayer over the adjusted basis of the assets transferred by the taxpayer. IRC 1031   permits certain types of exchanges to be made without current recognition of gain or loss. In those instances, generally, the gain or loss is postponed until the taxpayer disposes of the asset received in the exchange. However, unless one of the special provisions dealing with tax free exchanges applies, the entire gain must be recognized.

RRTA and Supplemental Employment Benefits Payments (SUB-Pay)

Railroads may offer severance pay to employees who voluntarily leave their employ.  Typically, the option for early out is only available to employees who meet minimum eligibility requirements such as age and years of service.     

The taxpayers argue that these payments are excludable from wages because they represent supplemental unemployment payments (SUB).

Revenue Ruling 75-44, 1975-1 C.B. 15, holds that severance pay is compensation for past services.

Revenue Ruling 56-249, 1956-1 C.B. 488, provides a limited exception from the definition of wages for FICA, FUTA and Federal income tax withholding for certain payments made upon the involuntary separation of an employee from the service of the employer.  It sets forth eight criteria for determining if payments meet the limited exception.

Subsequent revenue rulings have broadened the scope of Rev. Rul. 56-249.  Rev. Rul 58-128, 1958-1 C.B. 89, concludes that the wage conclusions in Rev. Rul 56-249 would be the same if the plan had been unilaterally instituted by the employer.  Rev. Rul 60-330, 1960-2 C.B. 46, further concludes that the fact that benefits are not paid from a trust does not alter the conclusion of Rev. Rul. 56-249.

Rev. Rul. 65-251, 1965-2 C.B. 395, holds that certain lump sum separation and severance allowances paid to laid-off employees in the railroad industry constitute compensation for RRTA purposes and wages for income tax withholding purposes.

Rev. Rul. 71-408, 1971-2 C.B. 340, holds that payments to employees pursuant to an agreement with a union upon the termination of their employment due to the discontinuance of the company's operations constitute wages for FICA, FUTA, and federal income tax withholding purposes. The payments described in  Rev. Rul. 71-408 do not meet the eligibility factors described in Rv. Rul. 56-249 and are not designed to provide a supplement to unemployment compensation.

Rev. Rul. 77-347, 1977-2 C.B. 362, amplifies and modifies Rev. 56-249 and 58-128.  Rev. Rul 77-347 provides that benefits under a plan do not have to be tied to state unemployment compensation benefits in order for the benefits to constitute SUB pay for FICA, FUTA, and federal income tax withholding purposes.

Rev. Rul 90-72, 1990-2 C.B. 211, provides the portion of Rev. Ru. 77-347 concluding that benefits do not have to be linked to state unemployment compensation in order to be excluded from the definition of wages for FICA and FUTA tax purposes is inconsistent with the underlying premises for the exclusion and is therefore hereby revoked. This action restores the distinction between SUB pay and dismissal pay by re-establishing the link between SUB pay and state unemployment compensation set forth in Rev. Rul 56-249.

Four 1999 decisions on FICA cases held voluntary severance payments to be compensation: Associated Electric Cooperative Inc. v. United States, 42 Fed.  Cl. 867 (1999), aff'd, 226 F.3d 1322 (Fed. Cir. 2000); Cohen v. United States, 63 F. Supp. 2d 1131 (C.D. Cal. 1999); Abrahamsen v. the United States, 44 Fed. Cl. 260 (1999), aff'd, 228 F.3d 1360 (Fed. Cir.), cert. denied, 532 U.S. 957 (2001); and Abbott v. United States, 76 F. Supp. 2d 236 (N.D.N.Y. 1999), aff'd 231 F.3d 889 (2d Cir. 2000), cert. denied, 532 U.S. 957 (2001)...

A fifth case held that early retirement payments made to tenured faculty members were payments made for the purchase of a property interest, namely tenure: North Dakota State University v. United States, 84 F. Supp.2d 1043 (D.N.D. 1999), aff'd, 255 F.3d 599 (8th Cir.2001).

In CSX Corp. Inc. v. United States, 52 Fed Cl. 208 (2002), the court considered the IRS’s definition of SUB-pay as set out in Revenue Ruling 56-249, the last modification to which was made by Revenue Ruling 90-72. The court rejected the IRS’s definition. Instead it looked to the definition of “supplemental unemployment compensation benefits” in IRC § 3402(o)(2), which applies to income tax withholding. Under this definition, the court found that some payments were compensation and some were not.

The parties subsequently filed motions for summary judgment.  CSX Corp. v. United States, 58 Fed. Cl. 341 (2003).  In revoking a private letter ruling (PLR), the IRS took the position that because the taxpayers' benefit recipients were disqualified from receiving government unemployment benefits, the benefits at issue were subject to tax as dismissal payments and did not qualify as supplemental unemployment compensation benefits (SUB pay) for purposes of the RRTA. The court addressed whether the favorable tax treatment accorded the taxpayers in the PLR was correct as a matter of law and whether the IRS's decision to revoke that favorable treatment lacked a rational basis and was thus an unlawful exercise of administrative authority. The court could not conclude that the IRS's decision to revoke the PLR deprived the taxpayers of any benefit to which similarly situated taxpayers were entitled.  Rev. Rul 90-72 did not apply because the taxpayer's plan was not qualified. It was more accurate to say that the revocation of the letter ruling withdrew a benefit not available to other taxpayers: the right to treat as SUB pay, payments made to employees who had volunteered for separation from employment. The fact that the ruling was revoked for admittedly incorrect reasons added nothing to the case.   The court granted the IRS's motion and denied CSX's' motion.

In a supplemental opinion, the court clarified that certain separation payments made to employees who declined a forced transfer were subject to federal employment taxes and that the railroad company's proof of the layoff status of its employees was sufficient.  See CSX Corp, Inc. v. United States, 71 Fed. Cl. 630 (2006).

The CSX case has been appealed and oral arguments were held in October 2007.

CSX Corp, Inc. v. United States, 71 Fed. Cl. 630 (2006) was appealed. The appellate court overturned the court of claims decision stating that even if payments satisfied the definition of SUB-Pay in § 3402(o), concerning income tax withholding, they are still taxable under FICA and RRTA (see Rev. Rul. 90-72, for guidance relative to SUB that is not taxable under FICA or RRTA). See CSX v. U.S., 518 F.3d 1328 (March 2008)

Whether amounts paid to employees from a Productivity Fund constitute compensation for purposes of RRTA.

In order to reduce costs, every major railroad has negotiated agreements with their employees to reduce the size of the crews operating their trains.  In return for agreeing to reduce the size of the crew, the employees receive additional payments from the employer.

The employer generally establishes a trust fund (Productivity Fund) and agrees to set aside a certain amount of money throughout the course of the year, based on the number of trains operated with a reduced crew.  Then, after year-end, each employee who participated in the operation of a train with a reduced crew receives a pro rata share of the funds set aside by the employer.

Some railroads do not treat these payments as compensation. 

While there are no cases directly on point, consideration should be given to the following.  In STA of Baltimore – ILA Container Royalty Fund v. United States, 621 F. Supp. 1567 (D. Md.1985), aff’d, 804 F.2d 296 (4th Cir. 1986), the court held that payments made by employers into a “container royalty fund” that were subsequently shared by eligible employees were “wages” for FICA and FUTA purposes.

Also consider other cases where payments were made from funds other than payroll funds and the courts concluded that the payments were wages.  NYSA-ILA Container Royalty Fund v. Commissioner, 847 F.2d 50 (2d Cir. 1988); Lane Processing Trust v. United States, 25 F.3d 662 (8th Cir. 1995); and Sheet Metal Workers Local 141 Supplemental Unemployment Benefit Trust Fund v. United States, 64 F.3d. 245 (6th Cir. 1995), cert. denied, 516 U.S. 1049 (1996).

Productivity Fund Buyout

Some railroads, having negotiated a productivity fund system as described above, have subsequently offered employees a lump sum payment in exchange for the employees’ giving up any rights to receive future payments from the productivity fund.  The timing of the payments vary, with some plans including future payment features.  Some railroads treat these payments as the purchase of a contractual right, not subject to RRTA.  In Revenue Ruling 58-301, 1958-1 C.B. 23,   the employer purchased the remaining years of an employment contract from an employee for a lump sum.  The ruling excludes the payment from compensation and treats it as the purchase of a contract right.  Thus, the payment is not subject to FICA and Federal income tax withholding.

Revenue Ruling 74-252, 1974-1 C.B. 287, concludes that payments made by an employer to an employee, following involuntary termination, under the provisions of a three-year contract are wages for FICA, FUTA, and Federal income tax withholding purposes. Under the terms of the contract, the employer could terminate the relationship at any time, provided the employee was paid an amount equal to an additional six months salary. The ruling distinguishes Rev. Rul. 58-301 on the basis that these payments are in the nature of dismissal payments provided for under the terms of the contract, rather than as consideration for the relinquishment of interests the employee had in the employment contract.

Revenue Ruling 75-44, 1975-1 C.B. 15, involves an employer's payment to a railroad employee as consideration for the employee's agreement to perform a different type of work and refrain from asserting his employment rights acquired pursuant to his past service under a general contract of employment.   The ruling concludes that the payment received by the employee is ordinary income in the taxable year of receipt and is "compensation" for purposes of the Railroad Retirement Tax Act (RRTA) and "wages" for purposes of Federal income tax withholding.   This ruling distinguishes Rev. Rul 58-301 on the basis that in Rev. Rul. 58-301 the lump sum payment was primarily in consideration of the cancellation of the employee's original contract rights rather than primarily in consideration of the past performance of services through which the relinquished employment rights were acquired.

Revenue Ruling 58-301 is modified and superceded by Revenue Ruling 2004-110, 2004-2 C.B. 960.  In the latter ruling, an employee performed services under a written employment contract. The contract did not provide for any payments to be made by either party in the event the contract was cancelled by mutual agreement. Before the end of the contract period, the parties agreed to cancel the contract and negotiate a payment to the employee in consideration for the employee's relinquishment of his contract rights. The Code and regulations provided that amounts an employer paid an employee as remuneration for employment were wages unless a specific exception applies under sections 3121(a), 3306(b), and 3401(a) and sections 31.3121(a)-1(b), 31.3306(b)-1(b), and 31.3401(a)-1(a)(1) of the regulations. As the employee did not provide clear, separate, and adequate consideration for the employer's payment that was not dependent upon the employer-employee relationship, the payment to the employee was wages for purposes of FICA, FUTA, and federal income tax withholding.

The proper treatment of this type payment is dependent on the facts.  If the correct technical position is unclear, consideration should be given to requesting a Technical Advice.

Railroad Grading Costs

Railroad grading and tunnel bores are all improvements resulting from excavations and tunneling, construction of embankments, clearings, diversions of roads and streams, sodding of slopes, and from similar work necessary to provide, construct, reconstruct, alter, protect, improve, replace, or restore a roadbed or right-of-way for railroad track. (I.R.C. § 168(e)(4))

“Any railroad grading or tunnel bore” is 50-year property (I.R.C. § 168(c)); depreciated on a straight-line basis (I.R.C. § 168(b)(3))
Grading is defined by the Surface Transportation Board (STB) in their uniform system of accounts, Account 3 (49 C.F.R. § 1201.3), to include “the cost of clearing and grading the roadway, and of constructing protection for the roadway, tracks, embankments and cuts.”

Class I Railroads must account for Grading Costs on their annual STB reports, Forms R-1 (see handout)

The American Association of Railroads (AAR) defines the term “Grading” as a verb, meaning “to prepare the ground for the reception of ballast and track.”

Generally, expenditures to reconstruct, alter, protect, replace, or restore an asset might be currently deductible.  However, all costs attributable to “railroad grading or tunnel bore” must as required by statute to be amortized over 50 years, and may not currently deducted. 

Any grading expenditures, even those to reconstruct, alter, protect, improve, replace, or restore a roadbed or right-of-way for railroad track must be capitalized and depreciated on a straight-line basis over a 50-year period

C.  Recent or Pending Legislation

Effective Date

Title

Summary and Impact of Legislation

None at this time

 

 

D.  Specific Industry Related Tax Law

Effective Date

Code Section

Summary and Impact of Law

1970

1.167(a)-11

Provides a depreciation system for property placed in service between 12-31-70 and 12-31-80.  Also provides system of expensing and capitalizing costs for same property.

With proper annual elections and record keeping, railroads can continue to use the CLADR repair allowance system with respect to this property that includes separate classes for rolling stock and road property such as bridges.

1981

168(b)(3)(c)

Limits ACRS deduction to straight line method for grading and tunnel bores

1981

168(c)

Specifies a 50 year recovery period for grading and tunnel bores

1981

168(e)(4)

Defines railroad grading and tunnel bores

Post

12-31-69

263(d)

Permits an annual election to expense amounts paid in connection with the rehabilitation of non-locomotive rolling stock, that would otherwise be considered additions to the capital account, up to a maximum of 20 percent of the basis of the property.

No longer effective

263(f)

Under RRB accounting, ties installed of any type material are afforded replacement, not betterment treatment.

Various

Chapter 22: Sections 3201 - 3233

Railroad Retirement Tax Act.  See also; index to Code for other miscellaneous related sections.

Not effective

Sec 3321

Railroad Unemployment Repayment Tax – no longer in effect, but could be reinstituted by the Railroad Retirement Board.

Post

12-31-04 to 1/1/08

§ 45G

Provides a 50% credit for any work performed, not only on track; but also on roadbed, bridges, and related track structures. The undefined term "related track structures" is taken to mean all the other structures along the track such as culverts, tunnels, stations, storage buildings, etc. The law permits Class II and III railroads to claim the credit; but also includes provisions for Class I railroads to claim it under certain circumstances.

E.  Important Revenue Rulings or Revenue Procedures

Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

1968 - Fwd

Rev Rul 67-22

Under the RRB accounting method, initial welding costs were considered betterment, and replacement-welding costs were expensed as a replacement.  This ruling has limited application after 12-31-86; but lends support to the argument that welding costs are a part of the capital asset rail’s cost basis under depreciation accounting.  The ruling states that welded rail reduces track renewal costs, prolongs the life of the rail and rolling stock, and substantially reduces maintenance and overhead costs.

1968-Fwd

Rev Rul 68-291

 

Where a taxpayer grants an easement that affects only a specific portion of an entire tract of land, only the basis allocable to the affected portion is reduced by the proceeds from the easement in determining gain.

1968-Fwd

Rev Rul 68-37

Where a taxpayer is awarded severance damages in a condemnation proceeding for damage done to a specific portion of his retained property, only the basis in that portion is reduced in determining the gain realized.

1970

Rev Rul 70-164

Loss on casualty to grading is limited to the FMV of the property before the casualty minus the FMV of the property after the casualty.  Cost of new grading must be capitalized. 

1973-Fwd

Rev Rul  73-161

Taxpayer, a land holding company, granted a 50 foot wide easement to a pipeline transmission company across a tract of its land.  Held, the proceeds from granting the easement are first used to offset the basis of that 50-foot wide strip of land and the excess over that basis is treated as gain.

1968-Fwd

Rev Rul 68-418

Under RRB accounting the costs of concrete ties used in replacement of wooden ties, was betterment.  However, see Rev Rul 84-22, which held to contrary.

1969-Fwd

Rev Rul 69-116

Describes certain expenditures with respect to freight cars that prolong or extend the useful life of freight cars.

1969- Fwd

Rev Rul 69-200

 

Describes airline industry expendable spare parts and rotable spare parts.  Holds that the former must be inventoried and expensed as used and that the latter must be depreciated identically to airplane itself.  Has potential application in railroad industry for locomotives.

1969-Fwd

Rev Rul 69-229

Railroad was required to bear portion of cost of highway bridge running above its tracks, but state, not railroad, held title to bridge.  Held, railroad was required to capitalize its share of the costs as an intangible asset in the form of a long-standing direct business benefit.

1969- Fwd

Rev Rul 69-476

The costs of rearranging a classification yard were treated as follows under the RRB method of accounting.  The installation of new track was capitalized.  The removal without replacement of other tracks was expensed, and the replacement of existing tracks was capitalized to the extent of betterment.  This ruling has limited application after 12-31-86.

1970-Fwd

Rev Rul 70-1

Railroad removed ballast to just below ties and then replaced with new ballast.  Under RRB method the cost of either a different, higher priced ballast or an increased depth of ballast constituted an improvement.  This ruling has limited application after 12-31-86.

1970-Fwd

Rev Rul 70-392

Taxpayer utility company relocated some of its existing assets that were already in use to a new location and continued their use, without extending their useful life or adding to their value.  Held, the costs to relocate were deductible under section 162.  This ruling has similar facts to railroad industry removal of rail and ties.

1973-Fwd

Rev Rul 73-203

A utility company was required by government to relocate its power transmission lines wherever they interfered with the construction of a new expressway.  These costs were required to be capitalized because they “rendered the property more valuable for the taxpayer’s use by bringing the property into compliance with applicable regulations.”  The costs of temporary relocation of the system for a period of less than a year for the purpose of maintaining service during construction were deductible.

1975-Fwd

Rev Rul 75-557

A connection fee which included a construction charge for the installation of a service line and water meter, that a new subdivision lot owner paid to obtain water service was includible in the public utilities gross income and was not a contribution to capital excludible under Section 118.

1977

Rev 77-478

Railroad, to prevent recurrent damage to its track embankment, undertook a project to construct a channel diversion of the river along with concrete dikes, dams and installed riprap along their embankment.  Bridges were extended and raised and pole driving and pressure grouting were used to firm up the embankment.

Relying on W.J. Wehrli v. Commissioner, 400 F. 2d 686 (10th Circuit, 1968) and Bank of Houston v. Commissioner, T.C. Memo 1960-110, the Service held that the entire costs of the project were part of a general plan of rehabilitation, modernization and improvement and must be capitalized.  Also held that incidental pressure grouting and pole driving at various unrelated spot locations were deductible.

1984-Fwd

Rev Rul 84-22

As the result of the decision in the case of Florida East Coast Railway v. United States (Ct. Cl. 1982), 82-2 USTC 9511, where due to developmental problems, concrete ties were held to not constitute a betterment, this Ruling held that concrete ties were not a betterment over wood ties.  Rev Rul 68-418 revoked.

1-186 Fwd

Rev Proc 87-56

MACRs Class Lives for railroad property are included here at Class 40.  The most common property classes are:

40.1 All machinery and equipment – freight cars locos, shop equipment etc. (7 years)

40.2   Structures and Similar improvements – Bridges, culverts, fences, shops, public improvements, roadway terminal buildings.  (20 years)

40.3   Wharves and docks, coal ore docks (15 years)

NOTE: Tunnels, tunnel bores and right of way grading have a 50 year life per Code Section 168 (c).

1988-Fwd

Rev Rul 88-57

A railroad that engages in the cyclical rehabilitation of its freight cars, where the car is stripped to its frame and completely rebuilt, must capitalize the costs under Section 263.

1998

Rev  Rul 98-25

The costs to replace underground storage tanks with tanks that comply with currently environmental laws are deductible.  This ruling has application to government required changes to railroad property such as crossings, bridges, etc.  However, see cases such as Teitelbuam v. Commissioner which held to the contrary

2000-Fwd

Rev Rul 2000-7

When taxpayer removes and retires an “asset”, the cost of removal must be offset against any proceeds from retirement salvage proceeds and should not be associated with the costs of a corresponding asset replacement project.

This ruling has some relevance to track projects to the extent that the “asset” is removed and retired.

2001 - Fwd

Rev. Rul. 2001-04

Costs incurred by a taxpayer to perform work on its aircraft airframe as part of a heavy maintenance visit generally are deductible as ordinary and necessary business expenses under section 162 of the Code.  This ruling has some relevance to maintenance performed on locomotives.

2001-Fwd

Rev. Proc. 2001-46

This revenue procedure provides a safe harbor method of accounting for track expenditures paid or incurred by Class I railroads.

2002-Fwd

Rev. Proc. 2002-65

This revenue procedure provides a safe harbor method of accounting for track expenditures paid or incurred by Class II or Class III railroads. Railroads not electing this, fall under a facts and circumstances accounting method.

F.  RRTA Rulings:

Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

 

1969-Fwd

Rev Rul 69-391

Whether the value of housing accommodations provided by a railroad to its section foremen is taxable compensation under RRTA.

If the parties have agreed that the value of housing accommodations are a part of the employee's total remuneration, then the value is compensation for RRTA purposes; otherwise, the amount is not compensation.

1974 - Fwd

Rev Rul 74-121

With respect to RRTA taxes, this revenue ruling adopted the position take in Southern Development Company v. Railroad Retirement Board, 243.2d 352 (8th Cir. 1957) which held that a subsidiary of a railroad was an employer within the meaning of the Railroad Retirement Act and the Railroad Unemployment Insurance Act under the jurisdiction of the Railroad Retirement Board.

1975-Fwd

Rev Rul 75-279

Generally, allowances for travel expenses are not wages subject to RRTA taxes if the employee is required to take a period for substantial rest away from home, or if the employee is away from home overnight while on service, and made a full accounting for the allowance.

Other allowances for shorter trips when the employee does not require substantial rest away from home or is not away from home overnight are includible in wages subject to RRTA taxes.

1975-Fwd

Rev Rul 75-565

Railroad employees' lump sum back pay is subject to RRTA taxes to the extent and at the rate of tax applicable when it was actually paid, unless the employee requests under Section 3231(e)(2) that these determinations be made on the basis of when the compensation was actually earned.

1991-Fwd

Rev Rul 90-72

Payments made to employees as result of plant closings, layoffs, reductions in force have to be linked to state unemployment compensation in order to be excluded from the definition of wages for employment tax purposes.  Also, lump sum payments are specifically not considered linked to state unemployment compensation for this purpose and are therefore not excludible as SUB (Supplemental Unemployment Benefits) pay.

1994-Fwd

Rev Proc 94-25

Established a safe harbor number for taxpayers to use in calculating the supplemental annuity tax (SAT) under the RRTA.  The safe harbor number of hours per employee per month is 164.  The safe harbor is optional, but must be applied to all employees for the entire calendar year if elected.

G.  Important Court Cases

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

 

1961-Fwd

Teitelbaum v. Commissioner, 294 F.2d 541, (1961) cert denied, 368 U.S. 987 (1962)

 

Municipal building ordinance required taxpayer to convert from DC to AC electrical current.  Held, the mere fact that the conversion was involuntary and made only to comply with city ordinance did not render it an ordinary expense.

Even though the change may not improve the property by increasing its attractive appearance or efficiency or prolonging its useful life, the property is more valuable because it is brought into compliance with applicable regulations.

This ruling has application to government required changes to railroad property such as crossings, bridges, etc.

1960-Fwd

Bank of Houston v. Commissioner, T.C. Memo 1960-110 & W.J. Wehrli v. Commissioner, 400 F. 2d 686 (10th Cir. 1968)

Both of these cases held that the costs of a project undertaken in an effort to carry out a “general plan” of rehabilitation, modernization, and improvement must be capitalized, even though some of the costs, standing alone, would be properly viewed as routine repair or maintenance items.

These cases have application to various types of railroad projects such as tunnel and bridgework, redesign of train yards, multi-component track replacement work, and building projects.

1970

True v. United States,, 894 F.2d 1197 (10th Cir. 1990)

Taxpayer relocated gas-processing machinery to another field because it had become uneconomical to operate in its present location.  Taxpayer dismantled, moved and reconstructed the property and in the process, repaired and overhauled it.  On appeal, the court reversed, holding that the cost of moving machinery, like the cost of repairing it, could result in a capital improvement.  Also, that the general plan of improvement espoused in Wherli does apply to costs other than simply repairs. 

Although many cases have held that relocating assets is a deductible expense, the court reached a different conclusion because it found that the moving expense at issue affected the long term income-producing capability of the asset moved.

This case has relevance to the track removal and relocation (cascading) issue.

1975

Mountain Fuel Supply Company v. United States, 449 F.2d 816 (10th Cir.), cert. denied, 405 U.S. 989 (1972)

Fuel company’s reconditioning of pipeline was a capital expenditure.  Taxpayer removed and reworked leak prone segments of the pipeline in 30-40 foot lengths, leaving some sections intact, replacing some with new pipe (about 10 percent) and reworking others.  The pipe had been in place 30 - 40 years.  After the reconditioning the pipe could transmit gas at a higher pressure than before. 

Relying in part on the general plan of improvement doctrine, the 10th Circuit overturned the lower court's decision and required the costs to be capitalized.

This case has relevance to the railroad industry track rehabilitation issue.

1975

Wolfsen Land & Cattle Co. V. Commissioner, 72 T.C. 1 (1979)

Rather than adopting a program of annual maintenance, taxpayer permitted its asset (irrigation system) to deteriorate over a period of years until it became dysfunctional.  At that time it expended considerable sums to restore it to original capacity.

Held, taxpayer was within its rights to eschew annual maintenance, but cost to restore it is a capital expenditure.

This case has application to the issue of deferred track maintenance, particularly as it relates to Class II and III railroads.

1990

Norwest Corp. v. Commissioner, 108 T.C.265 (1997)

Taxpayer decided to completely remodel their office building.  In the process, asbestos was removed and the cost of same was expensed.  Held, the asbestos removal was one part of an intertwined, general plan of rehabilitation and renovation that improved the building, and was required to be capitalized to that project.

This case is relevant to railroad projects involving track removal, bridge / tunnel component removal, and other similar right of way construction work.

1975

Cincinnati, New Orleans & Texas Pacific Railway Co. v. United States, 424 F.2d 563 (Ct. Cl. 1970), AND             Union Pacific Railroad Co. v. United States, 524 F.2d 1343 (Ct. Cl. 1975), cert. denied, 429 U.S. 827 (1976).

Whether railroads subject to regulation by the Interstate Commerce Commission (ICC) should be allowed to deduct currently expenditures incurred in acquiring "small items" with a cost of less than $500 each, as required by the ICC for financial accounting purposes.

The court held that while the accounting procedures required by the ICC are not binding upon the Commissioner, they had probative value in determining whether the taxpayer had a bona fide method of accounting.  The court concluded that items costing less than $500 did not constitute permanent improvements and that the taxpayer's method of accounting was in accordance with generally recognized accounting principles.

The AOD CC-1977-77 (July 15, 1977) on the CNOTP case states that although the issue should not be raised in pending railroad cases, the issue will be raised if a minimum capitalization rule is unreasonably high so that its use for tax purposes results in a definite and substantial reduction of the taxpayer's income.

1960

Kansas City Southern Railway Co. v. United States 112 F.Supp.164 (Ct. Cl. 1953)

 

Taxpayer corrected an immediate problem of limited and localized water pockets that developed in the sub grade below the track structure, by driving six-inch poles into the roadbed.  Held, this merely made the roadbed serviceable and did not improve or extend the life of it.

1985-Fwd

Kansas City Southern Railway Co. v. United States 112 F.Supp.164 (Ct. Cl. 1953)

Side Track Deposits are not taxable income they are refundable deposits.

1982-Fwd

Florida East Coast Railway v. United States, 82-2 USTC 951 (Ct. Cl. 1982), aff'd, 231 Ct. Cl. 1040 (1982)1

Concrete ties had extensive developmental failures.  Thus, they were held not to constitute “betterments” under RRB accounting.

This case is listed so that the point can be made that modern day concrete tie installations, in replacement of wood, do constitute an improvement.  There are no more developmental failures.

1960-Fwd

Denver Rio Grande Western R. R. Co v. Commissioner. 279 F. 2d 368 (10th Cir. 1960)

The taxpayer replaced 800 feet of floor planks and 85-90 percent of the stringers in a viaduct.  Held, the expenditure resulted in a substantial restoration, strengthening and improving the viaduct.  It was the replacement of a major portion of the viaduct that could no longer be repaired.

1947-Fwd

Inaja Land Co., Ltd. V Commissioner, 9 T.C. 727 (1947), acq. 1948-1 C.B. 2

A taxpayer who granted certain easements to allow a city to divert foreign waters into a river that flowed over his property was allowed to offset the proceeds against the basis in his entire property because it was impossible to know what portion of his land would have been affected by the flooding.

1974-Fwd

Fasken v. Commissioner, 71 T.C. 650 (1979, acq. 1979-2 C.B. 1)

The proceeds realized from the granting of four easements to their property must be offset only against that portion of their basis in the property that is allocable to the acreage affected by the easements.

This case is relevant to the allocation of basis in railroad right of way in determining gain from proceeds due to easements granted across same.

1970-Fwd

Iske v. Commissioner, T.C. Memo 1980-61

In determining gain realized on granting easements across his land, the basis allocable to the easements and not the entire basis is used.  Taxpayer could not show that it was impossible to allocate basis to areas affected.

This case is relevant to the allocation of basis in railroad right of way in determining gain from proceeds due to easements granted across same.

1973-Fwd

Chicago, Burlington, and Quincy R.R. Co. v. United States, 455 F. 2d 993 (Ct. CL. 1972) rev’d and rem’d on other grounds, 412 U.S. 401 (1973)

Cost of projects to modify existing improvements to divert water flow that was eroding a rail embankment were allowed as expense by lower court non-acq.

Taxpayer entered into a series of contracts with various states which provided that the states were to fund some or all of the costs of construction of grade separations (bridges over, or tunnels under the railroad track for use by highway vehicles) and grade safety equipment.  The railroad was to bear at least part of the costs of maintenance and replacement of the improvements once they had been installed.

The Supreme Court held that the cost of improvements made by the states were not contributions to capital on the railroad’s books.  Therefore, the taxpayer was not entitled to claim depreciation on the states’ portion of the costs.

12/31/80

Southern Pacific Transportation Co. v. Commissioner 75 T.C. 497 (1980).

Among many issues addressed by this case were the following:

Whether railroad could depreciate assets paid for by governmental bodies.  Typically, the costs borne by governments resulted from the replacement of railroad assets that were prematurely retired as the result of other government construction projects.  For example, the gov't built a dam which submerged railroad's property, built an Air Force runway that interfered with railroad's property, built a highway across railroad property, etc.  In each instance the government paid for relocation, reconstruction etc., to make railroad whole.

Held, the amounts spent by governments were not contributions of capital to the railroad, and thus were not depreciable (under the then existing statute).   Under the current statute, it would not be depreciable in any event even if it were a capital contribution

Held that the installation of welded rail in place of jointed rail was a betterment under RRB accounting.  (This rationale applies to depreciation accounting under current law.)

1/4/38

Helvering v. Claiborne-Annapolis Ferry Co., 93 F.2d 875 (4th Cir. 1938)

Payments by the state to maintain a ferry were considered to be income and not a capital contribution.  Payments were not for capital items but for operating expenses.

5/17/78

Springfield Street Railway Company vs. United States, 577 F.2d 700 (Ct. Cl. 1978)

 

Taxpayer was not required to use grants from the state to acquire capital assets.  The court ruled that these grants were not capital contributions.

The five tests set forth in the Chicago Burlington and Quincy case are controlling.

5/3/43

Detroit Edison Co. vs. Commissioner   319 U.S. 98 (1943)

Payments to the taxpayer by customers for the construction of facilities to provide service for these customers were not contribution of capital but were payments for service.

2/17/76

Union Pacific Railroad Company, Inc. vs. United S.tates,524 F.2d 1343;(Ct. Cl. 1975), cert. denied, 429 U.S. 829 (1976)

Payments by the government to relocate a portion of a rail line that was going to be submerged as the result of the construction of the dam were not capital contributions.  The Court ruled that the simple replacements of an existing facility left the railroad no better off than before and did not materially contribute to the production of additional income by the railroad.

9/9/76

Louisville and Nashville Railroad v. Commissioner, 66 T.C. 962 (1976), aff'd in part, rev'd in part, 641 F.2d 435 (6th Cir. 1981)

This case provides a detailed discussion of the characteristics, lives, and differences between relay rail, welded rail, and heat-treated rail.

This case provides extensive discussion of the process of rebuilding various types of freight cars, the costs involved, etc.  See below for Circuit Court opinion on this issue.

A third issued addressed is whether the railroad may treat the cost of highway grade crossing facilities paid for from public funds as contributions to capital, and depreciate them.  The state governments in which taxpayer operated, made grade crossing improvements that either provided bridges over the railroads tracks or tunnels beneath them.  The construction and design characteristics and other details were pursuant to written contracts with the railroad.  None of the agreements contained provisions with respect to legal title.  (To the extent that the railroad bore any costs involved, there was no dispute before the court.  Those costs were properly depreciable.)

The court held that they were not contributions to capital and thus not depreciable.  See also Supreme Ct case - United States v. Chicago, Burlington  & Quincy RR.  Co. 412 U.S. 401 [32 AFTR 2d 73-5042] (1973)

1976-Fwd

Louisville and Nashville Railroad v. Commissioner 641 F.2d 435 (6th Cir.1981)2

 

Circuit Court upheld lower court’s decision that railroad must capitalize as part of the cost of new and rebuilt freight cars: vacation pay, holiday pay, health and welfare benefits, and cost of transporting on its own lines the materials used in the project, but Circuit Court allowed the deduction of payroll taxes incurred relative to labor costs of project.

1974-Fwd

Commissioner v. Idaho Power Co., 418 U.S. 1 (1974)

 

With respect to what costs are to be included in the cost of self constructed assets, the court stated that where a taxpayer’s generally accepted method of accounting is made compulsory by the regulatory agency, and that method clearly reflects income, it is almost presumptively controlling of Federal income tax consequences.

2/15/32

Old Colony Railroad Co. v. Commissioner, 284 U.S.  552, (1932)

Regulatory agency imposed compulsory accounting practices do not necessarily dictate tax consequences.

6/14/71

Commissioner v. Lincoln Savings and Loan Assn,, 403 U.S. 34 (1971)

The dictates of regulatory authorities as to appropriate accounting practices are not irrelevant and may be accorded some significance in determining proper tax treatment.

H. RRTA Cases

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

 

1946- Fwd

Despatch Shops, Inc. v. Railroad Retirement Board, 153
F.2d 644 (2nd   Cir. 1946)

Whether Despatch was an employer within the meaning of the Railroad Unemployment Insurance Act.

The taxpayer argued that it should not be treated as a railroad employer because it was a separately incorporated manufacturing company distinct from its parent, a railroad, and because it was doing heavy repairs and manufacturing similar to that done by other, similar non-railroad companies.  The court rejected the argument.

1946- Fwd

Railroad Retirement Board v. Duquesne Warehouse Co., 326 U.S. 446(1946).

Whether Duquesne, a corporation owned by a railroad, was an employer within the meaning of the Railroad Retirement Act and the Railroad Unemployment Insurance Act.  The burden of loading and unloading railroad freight fell on the owner of the freight.  Duquesne charged the owner of the freight for loading and unloading the freight and performed other handling services in connection with the receipt and delivery of freight.  The Supreme Court held that service in connection with the transportation of property includes those activities which would be transportation services when performed by a railroad, but which it chooses to have performed by its affiliates.

1987- Fwd

Standard Office Building Corp. v. United States., 819 F.2d 1371 (7th Cir. 1987).

In this case, Standard, owner and operator of an office building, was controlled by a railroad and the office building was more than half occupied by offices of the railroad.

The appellate court held that the taxpayer was not covered by RRTA because it was incorporated prior to the passage in 1937 of the RRTA, and because its employees would have secured a pension windfall if covered under RRTA.  The portion of the building occupied by the railroad did not exceed 57 percent during the period in question.

1957-Fwd

Southern Development Co. v Railroad Retirement Board, 243 F.2d 351 (8th Cir. 1957).

 

Taxpayer was controlled by a railroad and owned an office building, 64 percent of which was occupied by offices of the railroad.  The railroad paid 73 percent of the total rents of the building equal to 39 percent of Southern’s total income.  Although Southern owned other properties all of its employees were engaged in the operation of the office building.  Based on these facts, Southern was held to be an employer within the meaning of the Railroad Retirement Act and the Railroad Unemployment Insurance Act.  For purposes of the RRTA, the rationale of Southern was adopted in Revenue Ruling 74-121, l974-l C.B. 300.

1983- Fwd

Missouri Pacific Truck Lines, Inc. v. United States, 3 CL. Ct. 14 (1983), aff'd per curiam,. 736 F.2d 706. (Fed. Cir.1984)

The activities of petitioner were found to fall within the trucking service exception under IRC 3231 and thus exempt from RRTA.

1986- Fwd

Atlantic Land & Improvement Co. v. United States, 790 F.2d 853 (11 Cir. 1986)

Owner of loading facility leased to railroad was an RRTA employer, and longshoremen were its employees.  Also, the expiration of the statute of limitations on the FICA returns filed on the longshoremen did not bar the assessment of taxes on those employees when converted under RRTA.

1991 - Fwd

City of Galveston, Texas v. United States, 33 Fed Cl. 685; (1995), aff'd without opinion, 82 F.3d 433 (Fed. Cir. 1996)

Held, the IRS has both the statutory authority and responsibility for determining whether a company is a carrier under RRTA.  The Railroad Retirement Board does not preclude the IRS from independently making these determinations despite the absence of a similar determination.

1983 Fwd.

Union Pacific Corporation v. United States, 26 Ct. Cl. 739 (1992), aff’d. 5F.3d 523 (Fed. Cir. 1993)

Held, the parent corporation and its railroad subsidiary were not "under common control" as defined under Section 3231(a) and thus the parent holding company did not meet the definition of an RRTA employer.

1990-Fwd*

Montana Rail Link v. United States, 873 F. Supp.1415 (D. Mont. 1994) aff’d. 76F.3d 991 (9th Cir. 1996)

This case upheld the validity of the retroactive effect of the Omnibus Budget Reconciliation Act as it applied to the taxability of employer contributions to Section 401(k) plans.  Although it generally only applied for years after 12-31-89, it did also apply to remuneration paid before 1-1-90, which the employer treated as compensation when paid.

3/2008

CSX v. U.S., 518 F.3d 1328 (March 2008)

even if payments satisfied the definition of SUB-Pay in § 3402(o), concerning income tax withholding, they are still taxable under FICA and RRTA (see Rev. Rul. 90-72, for guidance relative to SUB that is not taxable under FICA or RRTA)

3/2008

Trans-Serve Inc. v. U.S., 521 F.3d 462 (March 2008)).

A cross-tie manufacturer under common control with a railroad, to which it sold rail ties, was found to be a railroad employer, and therefore subject to RRTA taxes.

I.  Other Employment Tax Cases Potentially Impacting RRTA Issues

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

 

1986

STA of Baltimore—ILA Container Royalty Fund v. U.S. 621 F. Supp.  1567 (1985), aff’d, 804 F.2d 296 (4th Cir. 1986)

 Court held that the payments from the non-payroll, Container Royalty Fund were compensation.

1988

NYSA-ILA Container Royalty Fund by Bowers v. Commissioner, 847 F.2d 50 (2d Cir. 1988)

Court held that the payments from the non-payroll, Container Royalty Fund were compensation.

1995

Lane Processing Trust v. United States, 25 F.3d 662 (8th Cir. 1995)

Court held that the payments from a non-payroll, trust fund were compensation.

1995

Sheet Metal Workers Local 141 Supplemental Unemployment Benefit Trust Fund v. United States, 64 F.3d. 245 (6th Cir. 1995), cert. denied, 516 U.S. 1049 (1996)

Court addressed whether the source of funds used to make payments controls or impacts their treatment as compensation.  Court held that the payments from the non-payroll, Supplemental Unemployment Benefit Trust Fund were compensation.

1999

Associated Electric Cooperative Inc. v. United States, 42 Fed. Cl. 867 (1999), aff'd, 226 F.3d 1322 (fed. Cir. 2000);

Voluntary severance payments made to employees and former employees under workforce reduction plans held to be wages under FICA.

1999

Cohen v. United States, 63 F. Supp. 2d 1131 (C.D. Cal. 1999)

Voluntary severance payments made to employees and former employees under workforce reduction plans held to be wages under FICA.

1999

Abrahamsen v. United States, 44 Fed. Cl. 260 (1999), aff'd, 228 F.3d 1360 (fed. Cir. 2000), cert. denied, 532 U.S. 957 (2001)

Voluntary severance payments made to employees and former employees under workforce reduction plans held to be wages under FICA.

1999

Abbott v. United States, 76 F. Supp. 2d 236 (N.D. N.Y. 1999)

 

Voluntary severance payments made to employees and former employees under workforce reduction plans held to be wages under FICA.

1999

 

North Dakota State University vs. U.S. 255 F.3d 599 (8th Cir. 2001)

Early retirement payments made to tenured faculty members held to be payments for the purchase of tenure rights and not wages under FICA.

2000

Associated Electric Cooperative, Inc., v. United States, 42 Fed. Cl. 867 (1999), aff'd 226 F.3d 1322 (Fed. Cir. 2000)

Severance pay and early out payments paid to former employees constituted "wages" for purposes of Federal Insurance Contribution Act taxes. This case may have bearing on RRTA issues

 

2000

Abrahamsen v. United States, 44 Fed. Cl. 260 (1999), aff’d 228 F.3d 1360 (Fed. Cir. 2000), cert. denied, 532 U.S. 957 (2001)

Downsizing payments received by taxpayer employees upon signing a general release against their former employer were subject to federal income and Federal Insurance Contribution Act taxes as income and wages. This case may have bearing on RRTA issues

 

2002

Smith v. Commissioner, 330 F.3d 1023 (9th Cir. 2002), aff'g Vanalco, Inc. v. Commissioner, T.C. Memo. 1999-265

The Ninth Circuit upheld the Tax Court's ruling that the taxpayer must capitalize the costs of replacing both the linings of its aluminum reduction cells and portions of the brick floors in its cell rooms in its aluminum smelting facility. In upholding capitalization of the cell lining replacement, the Court explained that "the significance of the part under repair to the operation of the property is a critical inquiry." Thus, the Court found the Tax Court did not err in focusing on the essential functional nature of the cell lining rather than on whether its replacement added value to the cell. Further, given that the relining process effectively rebuilt the cell, the Tax Court did not err in ruling that relining conferred a new life expectancy on the cell equal to the three-year life expectancy of the lining.

This case is   pertinent to the locomotive cyclical maintenance issue.

J.  Technical Advice Memorandums - Field Service Advices

PLRs AND TAMs ARE ADDRESSED ONLY TO THE TAXPAYERS WHO REQUESTED THEM.  FSAs ARE NOT BINDING ON EXAMINATION OR APPEALS, NOR ARE THEY FINAL DETERMINATIONS.  FURTHERMORE, SECTION 6110(k)(3) PROVIDES THAT PLRs, TAMs, AND FSAs MAY NOT BE USED OR CITED AS PRECEDENT.    THE DOCUMENTS CITED BELOW ARE PROVIDED FOR ILLUSTRATIVE AND EXPLANATORY PURPOSES.  THEY PROVIDE AN INSIGHT AND UNDERSTANDING OF THE RATIONALE USED IN APPLYING THE LAW TO A GIVEN SET OF FACTS, WHICH MAY BE USEFUL IN CASES WITH SIMILAR FACTS AND CIRCUMSTANCES.

 

Date

Number

Description

Sep 20 1990

TAM 9050061

Certain severance payments made to non-union workers did not constitute wages for purposes of RRTA. 

Dec 21 1993

TAM 9416003

Revoked TAM 9050061 due to omission of material fact.  The workers in TAM 9050061 were prohibited from applying for state unemployment benefits by the terms of their SUB plan, but this fact was not disclosed in original submission of facts.

Sep 15 1993

FSA 1999-1117

The Service concluded that, under the matching principle, the costs to remove old railroad track during capitalized track installations should be capitalized and recovered over the depreciable life of the new track.

January 23, 1996

TAM 9618004

Cost incurred by the taxpayer for major inspections of aircraft engines may not be deducted as ordinary and necessary business expenses under IRC 162; but instead must be treated as capital expenditures under IRC 263. The major inspection costs had the effect of replacing the engine with a newly inspected and reconditioned engine

March 10, 2006

TAM 200610017

The taxpayer’s conveyances of its railroad rights-of-way are transfers of partial interests in real property. Provided that the transfers otherwise satisfy the requirements of I.R.C. § 170, the transfers would constitute deductible charitable contributions, only if the possibility that the property will revert to the taxpayer or its assigns is remote under Income Tax Regulations § 1.170A-7(a)(3). The determination of remoteness is factual for each conveyance.

June 11, 2004

TAM 200424001

Components of railroad track that are assembled and attached to the land and considered real property for state law purposes are not of like-kind to unassembled railroad track components considered personal property for state law purposes.

If the requirements of § 1031 are met, gain or loss is deferred when a taxpayer acquires railroad track components in a like-kind exchange notwithstanding that the taxpayer is unable to substantiate whether the acquired property was used for repair, program replacement, or new track construction.

The taxpayer’s practice of deeming § 1031 replacement property to be used first for capitalized track expenditures (including the 60% capitalized portion of the program replacement expenditures) is not proper. In particular, the first to capital convention of allocation is not consistent with the requirements of Rev. Proc. 2001-46 and may violate the reasonableness requirements of § 1.263A-1(f) of the Income Tax Regulations.

 

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