Cleveland Indians Strike Out.

• Author: Josephs, Stuart R.
• Position: Brief Article

Supreme Court: Back Wages Subject to Payroll Taxes When Paid

On April 17, the U.S. Supreme Court unanimously reversed the Sixth Circuit Court of Appeals, holding that back wages are subject to payroll (FICA and FUTA) taxes in the year paid-instead of the year that those wages should have been paid.

Under a grievance settlement agreement, the Cleveland Indians owed eight players back pay for wages due in 1986, and 14 players back pay for wages due in 1987. This back pay was paid in 1994.

The IRS asserted that these back wages should be taxed, for payroll purposes, in 1994. The Indians argued that those back wages should be taxed in 1986 and 1987.

Both the payroll tax rates and wage bases were higher in 1994 than in 1986 and 1987. Therefore, allocating the 1994 payments to 1986 and 1987 would generate no additional payroll taxes for the Indians or the players. But treating the back wages as taxable in 1994 would subject both the Indians and the players to significant tax liability. The government's brief described this issue as frequently recurring and affecting numerous employers and employees annually.

Path to Supreme court

Uncertain about the proper tax treatment, the Indians paid their share of payroll taxes on the back wages according to the 1994 tax rates and wage bases and then filed refund claims that the IRS denied. The Indians subsequently sued in the U.S. District Court for the Northern District of Ohio which ordered the refunds. The district court relied on the Sixth Circuit's 1987 decision in Bowman, which held that "[al settlement for back wages should not be allocated to the period when the employer finally pays but 'should be allocated to the periods when the regular wages were not paid as usual.'"

Bowman was based on the Supreme Court's 1946 decision in Nierotko, which held that to determine Social Security benefits' eligibility and amounts, back pay should be allocated to the year in which the wages would have been paid but for the employer's wrongful conduct.

However, the Fourth and Tenth Circuits in 1997 and 2000 (respectively) disagreed with Bowman and held that wages are taxed for FICA purposes in the year received. Nevertheless, the Sixth Circuit affirmed the Ohio District Court in an unpublished opinion filed May 10, 2000. The Supreme Court granted certiorari in 2000 to resolve this conflict.

Supreme Court's Decision

In its arguments, the government called attention to the constant statutory references to "wages paid...