Final Regs Provide Rules for RRTA Annuity Tax

 [4830-01-u]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations concerning the supplemental annuity tax under the Railroad Retirement Tax Act (RRTA). The regulations contain rules for calculating the work-hours subject to the tax. The regulations also contain a safe harbor that railroad employers may use to determine the taxable work-hours in lieu of calculating work-hours separately for each employee. The regulations provide railroad employers with guidance necessary to comply with the law and offer a simple safe-harbor calculation that can significantly reduce the burden on employers. The regulations affect all railroad employers and employee representatives.

 EFFECTIVE DATES: These regulations are effective for calendar years beginning after December 31, 1992, except that section 31.3221-3(d) is effective for calendar years beginning after December 31, 1993.

 FOR FURTHER INFORMATION CONTACT: Karin Loverud at 202-622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On May 13, 1993, the IRS published in the Federal Register (58 FR 28371) proposed amendments to the Employment Tax Regulations (26 CFR part 31) under section 3221(c) of the Internal Revenue Code (Code), which imposes a supplemental tax on railroad employers for each work-hour for which compensation is paid by the employer for services rendered to the employer during a calendar quarter.

 Two written comments were received from the public on the proposed regulations, and a public hearing was held on August 30, 1993. After consideration of the written comments received and the statements made at the public hearing, the proposed regulations are adopted by this Treasury decision.

EXPLANATION OF PROVISIONS

 Retirement benefits for railroad employees are provided under a system that currently combines elements similar to those under both the social security system and the private pension system.

 In addition to Tier I benefits (similar to social security benefits) and Tier II benefits (similar to private pension benefits), a supplemental retirement annuity was established in 1966 by Pub. L. 89-699 (1966 Act). The benefit provisions are administered by the Railroad Retirement Board (Board).

 The 1966 Act established a program to be administered by the Board for the payment of supplemental annuities for career railroad employees. The program, which was required to be self-financing, was to be financed separately from the regular railroad retirement program by imposing on railroad employers an excise tax under section 3221(c) of the Code. The rate was originally set at 2 cents for each work-hour of employment. In 1970, Pub. L. 91-215 replaced the 2-cent rate with a rate determined quarterly by the Board at a level sufficient to finance the annuities. The rate is currently 30 cents.

 The supplemental tax is imposed on every employer for each work- hour for which compensation is paid by the employer for services rendered to the employer during a calendar quarter. Section 3211(b) of the Code imposes a similar tax on employee representatives. No tax is imposed on employees to fund the supplemental annuities.

 The only guidance previously published with respect to the supplemental tax is in the instructions for Form CT-1, Employer's Annual Railroad Retirement and Unemployment Repayment Tax Return. The instructions today are nearly identical to the instructions 25 years ago. Nevertheless, in recent years, significant variations in the interpretation of the statutory language have arisen.

DEFINITION OF WORK-HOURS

 The final regulations, like the proposed regulations, do not change the longstanding interpretation of work-hours that was included in the instructions for Form CT-1 when the supplemental annuity tax was enacted. A commentator suggested that the 1970 legislation clarified that the term is limited to those hours both worked and paid for, and recommended that the regulations be revised accordingly. This recommendation has not been adopted for the reasons set forth below.

 The definition of work-hours as it appeared in the instructions for Form CT-1 was not changed following the 1970 legislation, because the IRS believed that the revised statutory language was not intended to change the meaning of work-hours, or to clarify its meaning. When the taxing provision was enacted in 1966, the tax was equal to 2 cents for each work-hour. The 1970 legislation changed the rate from 2 cents to a rate to be determined quarterly by the Board, beginning April 1, 1970. Because the rate would no longer be constant, Congress changed the statutory language to make it clear that the taxing period is a calendar quarter and that, for purposes of the tax, the timing of the services, not the timing of the payment for the services, governed.

 With respect to services rendered, the Treasury and the IRS believe that Congress intended to tax those hours for which the employee was paid both to perform and not to perform services. If an employee is guaranteed x hours of work a week and is paid for x hours, this is the number of hours to be taxed, even if there are less than x hours of work to be performed. The Treasury and the Service believe that this is so whether the employee is expected to report to the work site and do no work, whether the employee is not expected to report when no work is available, or whether the employee is not expected to report when no work is available but is expected to be available to be called to work.

 The 1970 legislation did not alter the statutory language regarding employees who receive daily, weekly, or monthly rates of compensation. The language is clear that the tax applies to the number of hours comprehended in the rate, plus overtime hours. Thus, if a monthly rate of compensation comprehends that the employee is entitled to time off from work for holiday time, vacation time, and sick time, all of those hours are taxed, not merely the hours during which the employee actually performed services.

SAFE HARBOR

 The final regulations retain a safe harbor method of calculating work-hours provided in the proposed regulations. Under the safe harbor, the employer counts the number of employees who received any compensation during the month and multiplies that figure by a "safe harbor number" to determine the number of work-hours subject to the tax. Each individual who is paid compensation is counted, even if the individual is a part-time, temporary, or seasonal employee. For purposes of the safe harbor count, it is irrelevant whether an employee actually performed any services for the employer during the month.

 The Treasury and the IRS believe that the safe harbor is an attractive method of significantly reducing administrative complexity, because the safe harbor will simplify calculation of the supplemental annuity tax. The Service has worked with the railroad industry in establishing a safe harbor number that will fairly and equitably implement the supplemental annuity tax provisions while providing a method of computing the liability that reduces the need to make a work-hour determination on an individual-by-individual basis. The Treasury and the IRS anticipate that, for most employers, use of the safe harbor number will result in fewer taxable hours, and the Board will adjust the tax rate accordingly.

 The regulations provide the Commissioner with the authority to publish the safe harbor number in guidance of general applicability. Pursuant to this grant of authority, a revenue procedure will be published to announce the safe harbor number. Commentators on the proposed regulations, representing both the Class I railroads and the Class III railroads, suggested a safe harbor number of 164. These comments have been taken into account in developing the revenue procedure.

RETROACTIVITY

 One commentator suggested that the safe harbor provision be made retroactive at the election of the taxpayer. Because the number the safe harbor produces is generally more favorable than work-hours calculated under the regulations, retroactive application of the safe harbor would, in many situations, produce taxable work-hours at levels below those anticipated when prior-period tax rates were set. Also, retroactive application would be inequitable because some taxpayers have many open tax years and others do not. For these reasons, the Treasury and the IRS have rejected any period of retroactivity and, therefore, this approach is not included in the final regulations. Thus, the safe harbor provision is effective for calendar years beginning after December 31, 1993, as proposed.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Karin Loverud of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR PART 31

 Employment taxes, Income taxes, Penalties, Pensions, Railroad retirement, Reporting and recordkeeping requirements, Social security, Unemployment compensation.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 31 is amended as follows:

PART 31 -- EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Paragraph 1. The authority citation for part 31 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 31.3211-3 is added to read as follows:

SECTION 31.3211-3 EMPLOYEE REPRESENTATIVE SUPPLEMENTAL TAX.

See paragraphs (a), (b), and (c) of section 31.3221-3 for rules applicable to the supplemental tax for each work-hour for which compensation is paid to an employee representative for services rendered as an employee representative.

Par. 3. Section 31.3221-3 is added under the heading "Tax on Employers" to read as follows:

SECTION 31.3221-3 SUPPLEMENTAL TAX.

(a) INTRODUCTION -- (1) IN GENERAL. Section 3221(c) imposes an excise tax on every employer, as defined in section 3231(a) and section 31.3231(a)-1, with respect to individuals employed by the employer. The tax is imposed for each work-hour for which the employer pays compensation, as defined in section 3231(e) and section 31.3231(e)-1, for services rendered to the employer during a calendar quarter. This section 31.3221-3 provides rules for determining the number of taxable work-hours.

(2) OVERVIEW. Paragraph (b) of this section defines work-hours. Paragraph (c) of this section demonstrates the calculation of work- hours. Paragraph (d) of this section offers a safe harbor calculation of work-hours for use by any employer in lieu of calculating the number of work-hours for each employee.

(b) DEFINITION OF WORK-HOURS -- (1) IN GENERAL. For purposes of section 3221(c) and this section, work-hours are hours for which the employee is compensated, whether or not the employee performs services.

(i) PAYMENTS INCLUDED IN WORK-HOURS. Work-hours include regular time worked; overtime; time paid for vacations and holidays; time allowed for meals; away-from-home terminal time; called and not used, runaround, and deadheading time; time for attending court, participating in investigations, and attending claim and safety meetings; and guaranteed time not worked. Work-hours also include conversion hours, that is, compensation converted into work-hours. Conversion hours may be derived from payment by the mile or by the piece. Work-hours also include time for which the employee is paid for periods of absence not due to sickness or accident disability, such as for routine medical and dental examinations or for time lost.

(ii) PAYMENTS EXCLUDED FROM WORK-HOURS. Certain kinds of payments are not subject to conversion into work-hours. These include those payments that are specifically excluded from compensation within the meaning of section 3231(e), such as certain sick pay payments (section 3231(e)(1)(i)); tips (section 3231(e)(1)(ii)); and amounts paid specifically (either as an advance, as reimbursement, or allowance) for traveling expenses (section 3231(e)(1)(iii)). Traveling expenses paid under a nonaccountable plan are excluded from work-hours even though they are includible in compensation. See section 31.3231(e)-1(a)(5). Also excluded from work-hours are amounts representing bonuses, amounts received pursuant to the exercise of an employee stock option, and all separation payments or severance allowances.

(2) HOURLY COMPENSATION. Because the tax under section 3221(c) is calculated on the basis of work-hours, the number of hours for which an employee receives compensation is the figure used to determine work-hours. In the case of an hourly-rated employee, each hour for which the employee receives compensation is one work-hour.

(3) DAILY, WEEKLY, MONTHLY COMPENSATION. (i) If an employee is paid by the day, week, month, or other period of time, the tax is imposed on the number of hours comprehended in the rate and, if any, the number of overtime hours for which additional compensation is paid. Thus, in the case of an office worker who receives an annual salary based on an 8-hour, 5-day-a-week work schedule that includes paid holidays, vacations, and sick time, the number of work-hours for one month is 174 (2088 hours/year / 12 months).

(ii) The rule in paragraph (b)(3)(i) of this section is illustrated by the following examples.

EXAMPLE 1. A, an office worker, receives an annual salary that is paid monthly. The salary is based on an 8-hour, Monday through Friday work schedule. A is not paid for overtime hours. A is not expected to work on holidays, during A's annual vacation, or during periods that A is ill. The number of work- hours for one month is 174 (2088 hours/year / 12 months). This figure remains constant, even though some months have more workdays than others.

EXAMPLE 2. B is paid a stated amount for each day B works, regardless of the number of hours worked. However, if B works more than 8 hours during any day, B is paid overtime for each additional hour worked that day. B is not paid for holidays, vacations, or sick time. During May, B worked 6 hours on 4 days, 7 hours on 6 days, 8 hours on 6 days, and 9 hours on 5 days. Because B is paid a daily rate for up to 8 hours, 8 hours are comprehended in the daily rate. Therefore, the number of work-hours for May is 173 (21 days x 8 hours/day + 5 overtime hours), even though B actually worked 159 hours.

(4) CONVERSION HOURS -- (i) Compensation not based on time (hour, day, month, etc.), such as compensation paid by the mile or by the piece, must be converted into the number of hours represented by the compensation paid. Thus, if an employee is paid by the mile, 1 work-hour equals the number of miles constituting a workday, divided by 8 hours. However, in the case of a collective bargaining agreement that specifies a number of hours as constituting a workday, the number of hours specified under the agreement may be used instead of 8.

(ii) The rule in paragraph (b)(4)(i) of this section is illustrated by the following example.

EXAMPLE. C's normal workday consists of 2 150-mile round trips that together take 6 hours. C is paid by the mile. The collective bargaining agreement does not specify the number of hours in a workday. Thus, the number of work-hours for each day C works is 8, or 1 work-hour for each 37.5 miles (300 miles/day / 8 hours/day). If the applicable collective bargaining agreement specifies that 6 hours constitute a workday, the number of work-hours for each day C works would be 6.

(c) CALCULATION OF WORK-HOURS -- (1) An employer may calculate the work-hours separately for each employee, as described in the examples in this paragraph. If the employer chooses to calculate work-hours separately for each employee, the employer must calculate the number of regular hours, overtime hours, and conversion hours for each employee for each month. In lieu of separate calculations, the employer may calculate the work-hours for all the employer's employees using the safe harbor formula described in paragraph (d) of this section.

(2) The rules in paragraph (c) of this section are illustrated by the following examples.

EXAMPLE 1. D worked 8 hours a day, Monday through Friday, during the months of February and March 1992. D did not work on President's Day, but was paid for the holiday. D's work-hours for February were 160 (19 days x 8 hours a day + 8 holiday hours). D's work-hours for March were 176 (22 days x 8 hours a day).

EXAMPLE 2. E worked 7-hour shifts every Tuesday through Saturday during the months of February and March 1992. E also worked 7 overtime hours during February and 21 overtime hours during March. Also, E was paid for 7 hours on President's Day, even though E did not work on that day. The number of work-hours for February was 161 (21 days x 7 hours a day + 7 overtime hours + 7 holiday hours). The number of work-hours for March was 168 (21 days x 7 hours a day + 21 overtime hours). Because E receives an hourly wage and was paid for the President's Day holiday, the number of hours (7) for which E was paid are added to the hours E actually worked. If E had worked on President's Day and had received extra pay for working on a holiday and holiday pay for 7 hours, the employer would include 14 hours in E's work-hours for that day, the 7 hours E actually worked and the 7 holiday hours for which E was paid.

EXAMPLE 3. EMPLOYMENT BEGINNING DURING MONTH. F began employment on March 16, a Monday, and worked 8 hours a day, Monday through Friday. The employer calculates that F's hours for the month were 96, because F worked 12 8-hour days during the month. If March 16 were on a Friday, the employer would calculate 11 days, or 88 hours.

EXAMPLE 4. EMPLOYMENT ENDING DURING MONTH. G's last day of employment was Friday, March 13. G worked 8 hours a day, Monday through Friday, except for March 3, when G was ill. G was paid for 8 hours for March 3. The employer calculates that G's work-hours for March were 80, because G worked 9 8-hour days and was paid for an additional 8 hours.

(d) SAFE HARBOR -- (1) IN GENERAL. In lieu of calculating work- hours separately for each employee, an employer may use the safe harbor for all employees. If the employer elects to use the safe harbor for a calendar year, the employer must use the safe harbor for all employees for the entire calendar year. If an employer uses the safe harbor for a calendar year, the employer need not elect the safe harbor for the following calendar year. An employer that elects the safe harbor for a calendar year may not subsequently elect to separately calculate employee work-hours for that calendar year.

(2) METHOD OF CALCULATION. The safe harbor treats each employee of the employer as receiving monthly compensation for a number of hours equal to the safe harbor number. To determine the number of work-hours for a month, the employer multiplies the safe harbor number by the number that equals the total number of employees to whom the employer paid compensation during the month.

(i) SAFE HARBOR NUMBER DEFINED. The safe harbor number is the number established in guidance of general applicability promulgated by the Commissioner.

(ii) EMPLOYEE DEFINED. Solely for purposes of this paragraph, an employee is any individual who is paid compensation, within the meaning of section 31.3231(e)-1, regardless of the amount, during the month. Thus, for example, a part-time, temporary, or seasonal employee is counted as an employee. A terminated employee is counted in the month of termination (provided the terminated employee received compensation in the month of termination), but not in any subsequent month in which the employee does not perform service for the employer as an employee, even if the terminated employee is paid compensation in a subsequent month. Thus, for example, an employee who terminates employment during the month, receives compensation during the month of termination, and receives a final paycheck the following month is counted as an employee of the employer for the month of termination but not for the following month.

(3) METHOD OF ELECTION. An employer makes the safe harbor election for a calendar year on the employment tax return filed for the previous calendar year.

(4) ADDITIONAL RULES. The Commissioner may, in revenue procedures, revenue rulings, notices, or other guidance of general applicability, revise the safe harbor number or provide additional safe harbors that satisfy section 3221(c).

(e) EFFECTIVE DATES. This section 31.3221-3 is effective for calendar years beginning after December 31, 1992, except that paragraph (d) is effective for calendar years beginning after December 31, 1993. Taxpayers may apply the rules in paragraphs (a), (b), and (c) of this section before January 1, 1993.