Rev. Rul. 75-44

Advice has been requested whether, under the circumstances described below, a lump-sum payment received by a railroad employee in recognition of his agreement to relinquish certain rights with respect to his employment acquired through prior service as an employee is ordinary income rather than gain from the sale or exchange of a capital asset and is "compensation for services" under the Railroad Retirement Tax Act and "wages" for purposes of the Collection of Income Tax at Source on Wages (chapters 22 and 24, respectively, subtitle C, Internal Revenue Code of 1954).

Because of his past service under a general contract of employment, the employee had acquired both the rights to security in his employment and to additional pay or other recognition for longevity. He then entered into an agreement with his employer to perform a different type of work and to refrain from asserting the employment rights he had previously acquired. In consideration thereof the employer agreed to pay him a lump sum.

It is the general rule that income from a transaction is not income from the sale or exchange of a capital asset unless the subject matter of the transaction is a capital asset within the meaning of section 1221 of the Code and disposed of in the manner required by section 1222. In this connection, Rev. Rul. 58-301, 1958-1 C.B. 23, holds, in part, that a lump-sum payment received by an employee as consideration for the cancellation of his employment contract is gross income to the recipient in the taxable year of receipt and is not gain from the sale of a capital asset.

However, that Revenue Ruling also holds that under the facts of that case the amount received by the employee is not subject to the provisions of section 3121 of the Federal Insurance Contributions Act (chapter 21, subtitle C of the Code) and section 3402 of the Code, relating to income tax withholding.

Section 3231(e) of the Railroad Retirement Tax Act provides, in part, that the term "compensation" means any form of money remuneration earned by an individual for services rendered as an employee to one or more employers.

Section 3401(a) of the Code, relating to income tax withholding, defines "wages" as all remuneration for services performed by an employee for his employer, with exceptions not material here.

In the instant case, the employee had acquired his relinquished employment rights through his previous performance of services whereas in Rev. Rul. 58-301, the contractual rights relinquished were acquired in the original negotiation of the contract canceled. 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.

Unlike the cited Revenue Ruling, the present case does not involve the cancellation of an employment contract which, at the outset, bound the parties for a specific period of time. Instead, the instant case is one of an employment contract which contemplated a relation between the parties that was to continue indefinitely, but that, except as might otherwise be specially provided under certain circumstances, was generally terminable by either party without liability to the other solely for the failure to maintain the relationship for a specified period. Hence, in this case, the amount received by the employee was a lump-sum settlement for the past performance of services reflected in the employment rights he was giving up, and was money remuneration for his services.

Accordingly, the lump-sum amount received by the employee is ordinary income to him in the taxable year of receipt and is "compensation" for purposes of the Railroad Retirement Tax Act and "wages" for purposes of income tax withholding.

Rev. Rul. 59-227, 1959-2 C.B. 13, which held that a lump-sum payment such as that in the instant case, received by a railroad employee, is gross income to the recipient in the taxable year of receipt but is not compensation for services rendered for purposes of the Railroad Retirement Tax Act or for purposes of the Collection of Income Tax at Source on Wages, is hereby modified with respect to the holdings applicable to the Railroad Retirement Tax Act and the Collection of Income Tax at Source on Wages and, as so modified, is superseded by this Revenue Ruling, which sets forth the holdings applicable to all the issues discussed in Rev. Rul. 59-227.

However, pursuant to the authority contained in section 7805(b) of the Code, lump-sum amounts such as those in the instant case will be treated as "compensation" and "wages" for purposes of asserting the taxes under the Railroad Retirement Tax Act and the Collection of Income Tax at Source on Wages, respectively, only if paid on and after February 18, 1975, the date of publication of this ruling in the Internal Revenue Bulletin.

Rev. Rul. 58-301 is distinguished and Rev. Rul. 59-227 is modified and superseded.