Part I. Rulings — Internal Revenue Bulletin 2004-50

Section 3121.—Definitions

26 CFR 31.3121(a)–1: Wages. (Also: §§ 3306, 3401, 31.3306(b)–1, 31.3401(a)–1.)

Signing or ratifying bonuses. This ruling holds that certain amounts paid to an employee as a signing bonus for a baseball contract or as a ratifying bonus pursuant to a collective bargaining agreement are wages for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source on Wages (federal income tax withholding). Rev. Ruls. 58–145 and 74–108 revoked. Rev. Ruls. 69–424 and 71–532 obsoleted.

Rev. Rul. 2004–109

ISSUE

Whether certain amounts an employer pays as bonuses for signing or ratifying a contract are wages for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source (Federal income tax withholding)?

FACTS

Situation 1. Baseball Club negotiates an employment contract with an individual player. It is the first contract between the Club and the player. The contract provides that the player receives a signing bonus if he reports for spring training at the time and place directed by the Club. The contract provides that the signing bonus is not contingent on the player’s future performance of services.

Situation 2. An employer negotiates a collective bargaining agreement (CBA) with a union representing a group of its employees. The CBA will take effect on the “ratification date,” which is the date it is ratified by a majority of the union members covered by the agreement. The CBA provides that each employee covered by the terms of the agreement who is employed by the employer as of the ratification date receives a bonus. Each such employee is paid the same amount regardless of compensation, seniority, position

and whether or not the employee voted for ratification. In addition, each eligible employee receives the payment even if the employee had not performed services for the employer before the ratification date. Finally, the CBA provides that the payment is not contingent on the employee’s future performance of services.

LAW

Sections 3101 and 3111 of the Internal Revenue Code (Code) impose FICA taxes on “wages,” as that term is defined in section 3121(a), with respect to “employment,” as that term is defined in section 3121(b). FICA taxes consist of the OldAge, Survivors and Disability Insurance tax (social security tax) and the Hospital Insurance tax (Medicare tax). These taxes are imposed on both the employer and employee. Sections 3101(a) and 3101(b) impose the employee portions of the social security tax and the Medicare tax, respectively. Sections 3111(a) and 3111(b) impose the employer portions of the social security tax and the Medicare tax, respectively.

The term “wages” is defined in section 3121(a) for FICA purposes as all remuneration for employment, with certain specific exceptions. Section 3121(b) defines the term “employment” as any service, of whatever nature, performed by an employee for the person employing him, with certain specific exceptions.

Section 31.3121(a)–1(b) of the Employment Tax Regulations provides that the term “wages” means all remuneration for employment unless specifically excepted under section 3121(a). Section 31.3121(a)–1(c) provides that the name by which the remuneration for employment is designated is immaterial. Salaries, fees, and bonuses are wages, if paid as compensation for employment. Section 31.3121(a)–1(d) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Section 31.3121(b)–3(b) defines employment as services performed by an employee for an employer, unless specifically excepted under section 3121(b).

The FUTA taxation provisions are similar to the FICA provisions, except that only the employer pays the tax imposed under FUTA. See sections 3301 and 3306(b) and the regulations thereunder. Although there are differences in the statutory exceptions to what constitutes wages and employment, the general definitions of the terms “wages” and “employment” for FUTA purposes are similar to the definitions for FICA purposes. See sections 3306(b) and 3306(c). Section 3402(a), relating to Federal income tax withholding, generally requires every employer making a payment of wages to deduct and withhold upon those wages a tax determined in accordance with prescribed tables or computational procedures. The term “wages” is defined in section 3401(a) for Federal income tax withholding purposes as all remuneration for services performed by an employee for his employer, with certain specific exceptions. Section 31.3401(a)–1(a)(2) provides that the name by which remuneration for services is designated is immaterial. Thus, salaries, fees and bonuses are wages if paid as compensation for services performed by the employee for his employer. Section 31.3401(a)–1(a)(3) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Unlike the FICA and the FUTA, the Federal income tax withholding provisions do not include a definition of employment.

Revenue Ruling 58–145, 1958–1 C.B. 360, in answering four specific questions, holds that a bonus paid by a baseball club to an individual solely for signing the individual’s first contract and not in any way contingent on the performance of subsequent services is not remuneration for services and, therefore, is not wages for purposes of Federal income tax withholding under section 3402. The ruling further holds that a bonus paid to a baseball player that is contingent upon the performance of subsequent services is wages subject to Federal income tax withholding.

Revenue Ruling 69–424, 1969–2 C.B. 15, holds that amounts paid by a baseball club for educational expenses of a minor league baseball player attending college

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and are not explicitly contingent on the performance of services.

Revenue Ruling 58–145 considered whether Federal income tax withholding applied to a bonus paid to a baseball player at the time a first contract was signed with a baseball club. It erred in its analysis by failing to apply the Code and regulations appropriately to the question of whether the bonus was wages in each of the four questions presented. Specifically, it failed to apply the correct definition of wages and to consider whether the bonus was paid in connection with establishing the employer-employee relationship. Accordingly, Rev. Rul. 58–145 is revoked. In addition, Rev. Rul. 74–108 is revoked as its conclusion relies upon Rev. Rul. 58–145.

HOLDING

Amounts an employer pays as bonuses for signing or ratifying a contract in connection with the establishment of the employer-employee relationship are wages for purposes of FICA, FUTA, and Federal income tax withholding. Accordingly, the payments in Situations 1 and 2 are wages for purposes of FICA, FUTA, and Federal income tax withholding.

EFFECT ON OTHER RULINGS

Rev. Rul. 58–145 and Rev. Rul. 74–108 are revoked. Rev. Rul. 69–424 and Rev. Rul. 71–532 are obsoleted in view of the amendment of section 117 by section 123(a) of the Tax Reform Act of 1986, 1986–3 (Vol.1) C.B. 1, 29. See section 117(c) and Notice 87–31, 1987–1 C.B. 475.

APPLICATION

Under the authority of section 7805(b), the Service will not apply the position adopted in this ruling to any signing bonus, sign-on fee, or similar amount paid to an employee in connection with the employee’s initial employment with the employer pursuant to a sign-on agreement or other contract entered into before January 12, 2005, provided the amount is paid under facts and circumstances that are substantially the same as in Rev. Rul. 58–145 or Rev. Rul. 74–108.

were not scholarships excluded from income under section 117 because the payments were “compensation for past, present or future employment services” within the meaning of section 1.117–4 of the Income Tax Regulations. The contract provided that the club was not required to make the payments if the player failed to attend the college for two consecutive years without proper reason, did not report for spring training as directed by the club, or was placed on the voluntarily retired, disqualified or ineligible list. The ruling holds that the payments are wages for Federal income tax withholding and FICA purposes.

Revenue Ruling 71–532, 1971–2 C.B. 356, holds that Rev. Rul. 69–424 is to be applied without retroactive effect with respect to wages paid prior to January 1, 1970. The ruling makes clear that the amount paid for certain educational expenses under the employment contract described in Rev. Rul. 69–424 is distinguishable from the bonus paid solely as consideration for signing a contract described in Rev. Rul. 58–145, but nonetheless limits the retroactive effect of Rev. Rul. 69–424.

Rev. Rul. 74–108, 1974–1 C.B. 248, analyzes whether a sign-on fee paid by a domestic corporation that operates a professional soccer club to a non-resident alien player as an inducement not to negotiate with any other team is treated as income from sources within or without the United States. Rev. Rul. 74–108 cites Rev. Rul. 58–145 as authority for the conclusion that the sign-on fee is not compensation for labor or personal services and that, therefore, source is not determined under the rules in section 861(a)(3) or 862(a)(3). Instead, Rev. Rul. 74–108 characterized the sign-on fee as a payment for a covenant not to compete both within and without the United States, with the result that the sign-on fee was attributable to sources both within and without the United States.

ANALYSIS

of the regulations. The regulations also provide that the name by which the remuneration is designated is immaterial. Salaries, fees, and bonuses, for example, are all wages, if paid as compensation for employment. Sections 31.3121(a)–1(c), 31.3306(b)–1(c), and 31.3401(a)–1(a)(2). The Code and the regulations also provide that any service of whatever nature performed by an employee for the person employing him is employment, unless a specific exemption applies. Sections 3121(b) and 3306(c) and sections 31.3121(b)–3(b) and 31.3306(c)–2(b). Employment encompasses the establishment, maintenance, furtherance, alteration, or cancellation of the employer-employee relationship or any of the terms and conditions thereof. If the employee provides clear, separate, and adequate consideration for the employer’s payment that is not dependent upon the employer-employee relationship and its component terms and conditions, the payment is not wages for purposes of FICA, FUTA, or Federal income tax withholding.

Under the facts presented in Situation 1, the individual receives the signing bonus in connection with establishing the employer-employee relationship. The individual does not provide clear, separate, and adequate consideration for the payment that is not dependent upon the employer-employee relationship and its component terms and conditions. Thus, the signing bonus is part of the compensation the Baseball Club pays as remuneration for employment, making it wages regardless of the fact that the contract provides that the bonus is not contingent on the performance of future services.

Under the facts presented in Situation 2, the employees receive the ratification bonus payments as part of a bargain that establishes the terms and conditions of the employment relationship with all of the employees covered by the CBA. The employees do not provide clear, separate, and adequate consideration for the employer’s payments that is not dependent upon the employer-employee relationship and its component terms and conditions. The payments are part of the compensation the employer pays as remuneration for employment. Thus, the ratification bonuses are wages regardless of the fact that they are uniform in amount, do not vary based on seniority or position or any other factor,

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Insurance tax (Medicare tax). These taxes are imposed on both the employer and employee. Sections 3101(a) and 3101(b) impose the employee portions of the social security tax and the Medicare tax, respectively. Sections 3111(a) and 3111(b) impose the employer portions of the social security tax and the Medicare tax, respectively.

The term “wages” is defined in section 3121(a) for FICA purposes as all remuneration for employment, with certain specific exceptions. Section 3121(b) defines “employment” as any service, of whatever nature, performed by an employee for the person employing him, with certain specific exceptions.

Section 31.3121(a)–1(b) of the Employment Tax Regulations provides that the term “wages” means all remuneration for employment unless specifically excepted under section 3121(a). Section 31.3121(a)–1(c) provides that the name by which the remuneration for employment is designated is immaterial. Section 31.3121(a)–1(d) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Section 31.3121(b)–3(b) defines employment as services performed by an employee for an employer, unless specifically excepted under section 3121(b).

Section 31.3121(a)–1(i) provides that remuneration, unless specifically excepted, constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services were performed and the individual who performed them.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Marie Cashman and Stephen Suetterlein of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue ruling, contact Mr. Suetterlein at (202) 622–6040 (not a toll-free call).

26 CFR 31.3121(a)–1: Wages. (Also: §§ 1221, 1222, 3306, 3401, 1.1221–1, 1.1222–1, 31.3306(b)–1, 31.3401(a)–1.)

Contract cancellation; employment contract. This ruling holds that an amount paid to an employee as consideration for cancellation of an employment contract and relinquishment of contract rights is ordinary income and wages for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source (federal income tax withholding). Rev. Ruls. 55–520 and 58-301 modified and superseded. Rev. Ruls. 74–252 and 75–44 modified.

Rev. Rul. 2004–110

ISSUE

Whether an amount paid to an employee as consideration for the cancellation of an employment contract and relinquishment of contract rights is ordinary income, and wages for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source (Federal income tax withholding)?

FACTS

An employee performs services under a written employment contract providing for a specified number of years of employment. The contract does not provide for any payments to be made by either party in the event the contract is cancelled by mutual agreement. Before the end of the contract period, the employee and the employer agree to cancel the contract and negotiate a payment from the employer to the employee in consideration for the employee’s relinquishment of his contract

rights to the remaining period of employment.

LAW

Ordinary Income

Section 1(h) of the Internal Revenue Code (Code) provides for maximum capital gains tax rates on net capital gain.

Section 1222(11) defines “net capital gain” as the excess of net long-term capital gain over net short-term capital loss. Under section 1222(3), the term “long-term capital gain” means gain from the sale or exchange of a capital asset held for more than one year.

Section 1221 provides that the term “capital asset” means property held by the taxpayer, with certain exclusions listed in section 1221(a)(1)-(8).

Section 1231 provides generally for capital gain or loss if there is net gain from the sale or exchange of property used in a trade or business and from certain involuntary conversions of business or investment property.

The United States Supreme Court has held that not everything that can be called “property” in the ordinary sense and that is outside the statutory exclusions in section 1221 or section 1231 qualifies as a “capital asset” under section 1221 or for purposes of section 1231, and that the term does not include certain claims or rights, the consideration for which essentially substitutes for ordinary income. See Commissioner v. Gillette Motor Transport, Inc., 364 U.S. 130, 134–136 (1960), Ct. D. 1853, 1960–2 C.B. 466, 468; Commissioner v. P.G. Lake, Inc., 356 U.S. 260, 265–67 (1958), Ct. D. 1823, 1958–1 C.B. 516, 518–19. Under this line of Supreme Court decisions, it is settled that consideration received for the transfer or termination of a right to receive income for the past or future performance of services is taxable as ordinary income. See, e.g., Rothstein v. Commissioner, 90 T.C. 488, 493–94 (1988).

Wages

Sections 3101 and 3111 impose FICA taxes on “wages,” as that term is defined in section 3121(a), with respect to “employment,” as that term is defined in section 3121(b). FICA taxes consist of the OldAge, Survivors and Disability Insurance tax (social security tax) and the Hospital

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Employment encompasses the establishment, maintenance, furtherance, alteration, or cancellation of the employer-employee relationship or any of the terms and conditions thereof. If the employee provides clear, separate, and adequate consideration for the employer’s payment that is not dependent upon the employer-employee relationship and its component terms and conditions, the payment is not wages for purposes of FICA, FUTA, or Federal income tax withholding.

Under the facts presented in this ruling, the employee receives the payment as consideration for canceling the remaining period of his employment contract and relinquishing his contract rights. As such, the payment is part of the compensation the employer pays as remuneration for employment. The employee does not provide clear, separate, and adequate consideration for the employer’s payment that is not dependent upon the employer-employee relationship and its component terms and conditions. Thus, the payment provided by the employer to the employee is wages for purposes of FICA, FUTA, and Federal income tax withholding. This conclusion applies regardless of the name by which the remuneration is designated or whether the employment relationship still exists at the time the payment is made.

With respect to the application of FICA and Federal income tax withholding, Rev. Rul. 55–520 and Rev. Rul. 58–301 erred in their analysis by failing to apply the Code and regulations appropriately to the question of whether the payments made in cancellation of the employment contract were wages.

To qualify as capital gain, eligible for the reduced rates in section 1(h), a payment must be received in connection with a “sale or exchange” of “property,” as those terms are used in sections 1221, 1222, and 1231. Under Gillette Motor, P.G. Lake, and the settled line of authority applying the Supreme Court’s reasoning to compensation-related rights, consideration received for the transfer or termination of a right to receive income for the past or future performance of services is a substitute for ordinary income, taxable as such. The payment received by the employee in the present situation is a payment of this type, and for capital gains purposes is not a payment for property. It is therefore taxable to the employee as ordinary income.

with prescribed tables or computational procedures. The term “wages” is defined in section 3401(a) for Federal income tax withholding purposes as all remuneration for services performed by an employee for his employer, with certain specific exceptions. Section 31.3401(a)–1(a)(2) provides that the name by which remuneration for services is designated is immaterial. Section 31.3401(a)–1(a)(3) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Unlike the FICA and the FUTA, the Federal income tax withholding provisions do not include a definition of employment.

Section 31.3401(a)–1(a)(5) provides that remuneration, unless specifically excepted, constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services were performed and the individual who performed them.

Revenue Ruling 55–520, 1955–2 C.B. 393, concludes that an amount paid to an individual as a compromise settlement for the cancellation, before the normal expiration date, of a two-year employment contract is not wages for FICA and Federal income tax withholding purposes. The ruling further concludes that the payment is includible in the employee’s gross income for Federal income tax purposes.

Revenue Ruling 58–301, 1958–1 C.B. 23, concludes that a lump sum payment received by an employee as consideration for his agreement to cancel the remaining period of a five-year employment contract during the second year of the term and to relinquish his contract rights is ordinary income, not capital gain, and is includible in his gross income in the year of receipt. The ruling further concludes that 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 dis

tinguishes 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.

ANALYSIS

The Code and regulations provide that amounts an employer pays an employee as remuneration for employment are wages, unless a specific exception applies. 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. The regulations also provide that the name by which the remuneration is designated is immaterial. Sections 31.3121(a)–1(c), 31.3306(b)–1(c), and 31.3401(a)–1(a)(2). Furthermore, the remuneration is wages even though at the time paid the relationship of employer and employee no longer exists. Sections 31.3121(a)–1(i), 31.3306(b)–1(i), and 31.3401(a)–1(a)(5). The Code and the regulations also provide that any service of whatever nature performed by an employee for the person employing him is employment, unless a specific exemption applies. Sections 3121(b) and 3306(c) and sections 31.3121(b)–3(b) and 31.3306(c)–2(b).

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facts and circumstances that are substantially the same as in Rev. Rul. 55–520 or Rev. Rul. 58–301.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Michael Swim and Elliot Rogers of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue ruling, contact Mr. Rogers at (202) 622–6040 (not a toll-free call).

With respect to the ordinary or capital character of a payment, the payments in Rev. Rul. 55–520, Rev. Rul. 58–301, Rev. Rul. 74–252, and Rev. Rul. 75–44 are ordinary income; in particular, the specific holdings to this effect in Rev. Rul. 58–301 and Rev. Rul. 75–44 remain correct.

Accordingly, Rev. Rul. 55–520 and Rev. Rul. 58–301 are modified and superseded. In addition, Rev. Rul. 74–252 and Rev. Rul. 75–44 are modified to the extent their holdings regarding FICA, FUTA, RRTA, and Federal income tax withholding rely on distinguishing Rev. Rul. 58–301.

HOLDING

An amount paid to an employee as consideration for cancellation of an employ

ment contract and relinquishment of contract rights is ordinary income, and wages for purposes of FICA, FUTA, and Federal income tax withholding.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 55–520 and Rev. Rul. 58–301 are modified and superseded. Rev. Rul. 74–252 and Rev. Rul. 75–44 are modified.

APPLICATION

Under the authority of section 7805(b), the Service will not apply the position adopted in this ruling to any payment that an employer made to an employee or former employee before January 12, 2005, provided that the payment is made under

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