Taxation of Lost Wages Awards Under the FELA: the Illinois Appellate Court Applies Loos v. BNSF

ABSTRACT: The U.S. Supreme Court recently resolved a split among state and federal courts on the issue of whether lost wages under the Federal Employers' Liability Act (FELA) are taxable under the Railroad Retirement Tax Act (RRTA). The Illinois Appellate Court was one of the first in the nation to apply the Supreme Court's holding that awards of lost wages in FELA cases are taxable.

In Munoz v. Norfolk Southern Railway Company, 2018 IL App (1^st) 171009 (Munoz I), Plaintiff Munoz sued his railroad employer under the FELA for an on-duty personal injury. A jury awarded Munoz a large sum attributed to past and future lost wages. After the verdict, the railroad moved for a setoff, claiming Munoz owed taxes on the lost wages award under the Railroad Retirement Tax Act (RRTA). Munoz argued that the award of lost wages should be treated the same as personal injury awards that are not subject to income taxes. 

The trial court denied the railroad’s motion, relying on the Missouri Supreme Court’s opinion in Mickey v. BNSF Railway Co., 437 S.W. 2d 207 (Mo. banc 2014). In Mickey, the Missouri Supreme Court held that, like the exclusion for personal injury awards under Internal Revenue Code § 104(a)(2), an FELA lost wages award does not constitute income. Therefore, lost wages do not qualify as taxable compensation under the RRTA.

The railroad appealed, arguing that the plain language of the RRTA, when read in conjunction with the Railroad Retirement Act, supports a finding that an FELA lost wages award is compensation subject to withholding taxes. The Illinois Appellate Court disagreed and affirmed the trial court. The Appellate Court found that the RRTA defines “compensation” as money paid to an employee for “services rendered” and lost wages cannot be paid to an employee for “services rendered”.

Shortly thereafter, the U.S. Supreme Court considered the same issue in BNSF Railway Co. v. Loos, 129 S. Ct. 893 (2019), and held that FELA lost wages awards are compensation subject to taxation. The Illinois Supreme Court then directed the Appellate Court to vacate its initial judgment in Munoz I and consider the effect of the Loos case. Upon reconsideration, the Appellate Court concluded that Munoz’s lost wages award was taxable compensation under the RRTA. Munoz v. Norfolk Southern Railway Company, 2019 IL App (1^st) 171009-B (Munoz II).

The Munoz II  Court observed that in Loos the Supreme Court looked to the Social Security Act (SSA) and the Federal Insurance Contributions Act (FICA) for guidance as to the meaning of “compensation.”  The Supreme Court found that the RRTA’s definition of compensation was “materially indistinguishable” from FICA’s definition of “wages”, to include remuneration for “any service, of whatever nature, performed . . . by an employee.”

Previous Supreme Court cases held that “wages” under the SSA and FICA included awards of backpay and severance payments.  These cases held that such awards represented pay for active service, in addition to pay for periods of absence from active service.  As a result, the Supreme Court held that “compensation” under the RRTA can encompass pay for periods of absence from active service, as long as the remuneration in question “stems from the employer-employee relationship.”

The Supreme Court found that damages for lost wages awarded under the FELA “fit comfortably” within these parameters. Wage loss damages compensate an employee for time during which he or she is “wrongfully separated” from employment, and this is akin to an award of back pay. An award of back pay that compensates an employee for wrongful discharge constitutes wages under the SSA, even though the wages were awarded because of the employer’s wrongdoing.  Based on this reasoning, “there should be no dispositive difference between a payment voluntarily made and one required by law.”

The Munoz II Court reiterated the distinction between personal injury damages that are not taxable under the Internal Revenue Code with FELA lost wage awards. Personal injury damages are excluded from “gross income” by the Code. And, “gross income” cannot be conflated with “compensation” under the RRTA, which Congress treated as discrete tax bases.

CONCLUSION

The Illinois Appellate Court is likely the first of many courts that will apply the Loos decision and find that an award of lost wages in an FELA case is subject to taxation. The resolution of the split on this issue will have practical ramifications in FELA litigation, including modification of jury instructions and, potentially, attempts to allocate settlement proceeds to sources other than lost wages.


* Kelly M. “Koki” Sabatés, Summer Law Clerk, assisted in the research and drafting of this post. Sabatés is a 3L student at the University of Missouri-Columbia.