Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Tenure Trap: Third Circuit Joins Sixth in Holding Tenure Buy-out Payments Subject to FICA Taxation in University of Pittsburgh v. United States
Daniel C. Sale
In University of Pittsburgh v. United States, the Third Circuit held that early retirement payments to professors, which required the relinquishment of tenure rights, qualified as wages subject to Federal Insurance Contributions Act (FICA) taxation. The University of Pittsburgh (the University) argued that the early retirement payments were not wages, but rather buy-outs not subject to FICA taxation. The Third Circuit, however, disagreed and ruled that because “tenure is a form of compensation for past services to the University, payments offered as a substitute for tenure are compensation and therefore taxable as wages.”
Two other circuit courts have grappled with the issue of whether the buy-out of tenure rights constitute wages under FICA and have reached opposite conclusions. Because of the peculiarities of the university tenure system, and the fact that the concept of wages for FICA tax purposes does not enjoy a clear definition, the Supreme Court may very well have to resolve the issue.
Part II of this Note provides an overview of FICA and the various revenue rulings promulgated by the Service regarding FICA taxation and early retirement payments. Part II also discusses the relevant case law, including the split between the Sixth and Eighth Circuits, addressing whether early retirement payments to induce relinquishment of tenure are subject to FICA taxation. Part III discusses the facts at issue in University of Pittsburgh, the district court’s decision in favor of the taxpayer, and the Third Circuit’s reversal of that decision based on its conclusion that because tenure is a form of compensation for past services to the University, payments offered as a substitute for tenure are compensation and therefore taxable as wages. Part IV analyzes the Third Circuit’s opinion in University of Pittsburgh and recommends the opposite result. As will be explained in this Note, the payments to induce early retirement by tenured professors should not be considered wages because they were given primarily in exchange for the faculty members’ relinquishment of tenure, a valuable property right, rather than as a reward for past service to the University. Part V suggests several arguments universities might make to increase the likelihood that tenure buy-outs will not be subject to FICA taxation in future litigation.