Univ Chicago v. United States

In the
United States Court of Appeals
For the Seventh Circuit
No. 07-3686
U NIVERSITY OF C HICAGO,
Plaintiff-Appellant,
v.
U NITED S TATES OF A MERICA,
Defendant-Appellee.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 06 C 3452—George W. Lindberg, Judge.
A RGUED JUNE 3, 2008—D ECIDED O CTOBER 29, 2008
Before K ANNE, S YKES, and T INDER, Circuit Judges.
T INDER, Circuit Judge. This appeal considers the
meaning of the phrase “salary reduction agreement.” The
University of Chicago did not pay, report, or withhold
Federal Insurance Contributions Act (FICA) tax between
2000 and 2003 for payments made under its employee re-
tirement plans. The Internal Revenue Service (IRS) assessed
FICA tax plus penalties and interest on contributions
made under the University’s retirement plans. In this
case, FICA tax liability turns upon whether the payments
2 No. 07-3686
made under the plans were pursuant to “salary reduction
agreements.” The University is currently appealing from
the district court’s grant of summary judgment in favor
of the government. We affirm.
I. Background
The University of Chicago, one of the world’s foremost
universities, is an Illinois not-for-profit corporation. As is
relevant to this appeal, the University maintains two
retirement plans for its employees, the Contributory
Retirement Plan (CRP) and the Retirement Income Plan
for Employees (ERIP). CRP applies to academic and
highly compensated employees, and ERIP applies to
nonacademic and lower-compensated employees. Partici-
pation in the applicable plan is mandatory for all eligible
employees as a condition of employment.1 The plans
require employees to “contribute” specified percentages
of their salaries; the University, in turn, contributes
additional amounts, specified as percentages of the em-
ployees’ salaries. For example, under CRP during the 2000-
2003 tax years, an employee was required to contribute
5% of her salary, and the University was required to
contribute an amount equal to 7.5% of the employee’s
1
Certain employees can participate only on a voluntary basis,
such as employees who are under age twenty-five or have not
yet completed two years of service. The University of Chicago
does not contest that FICA tax was properly assessed as to the
contributions for voluntary participants; only the FICA tax
for mandatory plan participants is at issue in this case.
No. 07-3686 3
salary. The contributions by the employee and employer
are used to fund the purchase of annuity contracts on
behalf of the employee. ERIP functions similarly.
FICA is a payroll tax that funds Social Security and
Medicare programs. An employee and employer are
both taxed 6.2% of the employee’s wages for Social
Security (up to a specified limit) and 1.45% of the em-
ployee’s wages for Medicare. 26 U.S.C. §§ 3101, 3111. An
employer is required to deduct and withhold the em-
ployee’s share of FICA taxes from the employee’s wages,
remit the withheld taxes to the IRS every quarter, and
report the amount of withheld taxes on a quarterly tax
return. Diamond Plating Co. v. United States, 390 F.3d
1035, 1037-38 (7th Cir. 2004) (citing §§ 3101-3111). The
employer is liable for the tax that it is required to deduct
and withhold from the employee. 26 U.S.C. § 3102. Em-
ployers are subject to penalties for failure to deposit taxes
“unless it is shown that such failure is due to reasonable
cause and not due to willful neglect.” Id. § 6656(a).
The employer and employee tax liability for FICA turns
upon the definition of “wages” in the Internal Revenue
Code; the term is broadly defined but followed by
specific exceptions. Univ. of Chi. Hosp. v. United States,
No. 07-1838, 2008 WL 4301442, at *2 (7th Cir. Sept. 23,
2008). “Wages” includes “all remuneration for employ-
ment,” but certain kinds of payments are excepted.
26 U.S.C. § 3121(a)(1)-(23). The exception at issue here
includes “any payment made to, or on behalf of, an em-
ployee or his beneficiary . . . under or to an annuity con-
tract described in section 403(b), other than a payment
4 No. 07-3686
for the purchase of such contract which is made by
reason of a salary reduction agreement (whether evid-
enced by a written instrument or otherwise).” Id.§ 3121(a)(5)(D).
On May 13, 2005, the IRS assessed the University with
additional FICA taxes, as well as failure to deposit penal-
ties and interest for each quarter during the 2000-2003
tax years, based upon the University’s failure to report,
withhold, or pay FICA taxes on the payments made
under CRP and ERIP. The University paid divisible
portions of the assessed amounts.2 The IRS later assessed
additional penalties based on the University’s failure
to pay the full amounts originally assessed, and the
University also paid divisible portions of those addi-
tional penalties and interest. The University claimed
refunds from the IRS, which the IRS denied. The University
then filed suit in the Northern District of Illinois chal-
lenging the refund denials; the government counter-
claimed for the unpaid portions of the assessed amounts.
Both parties moved for summary judgment. The district
court considered and rejected the University’s argument
that the language “made by reason of a salary reduction
agreement” is ambiguous. Univ. of Chi. v. United States,
No. 06-C-3452, 2007 WL 2409793, at *2 (N.D. Ill. Aug. 22,
2
The “divisible tax doctrine” allows a taxpayer to challenge
an assessment of a divisible tax in the district court without
paying the full assessed amount. Ruth v. United States, 823
F.2d 1091, 1093 (7th Cir. 1987). We will discuss this in more
detail in Part III, infra.
No. 07-3686 5
2007). The court concluded that both plans fell “squarely
within” the definition of “wages” and if Congress had
intended the subsection to apply only to “individually
negotiated salary reduction agreements,” as the University
suggested, Congress would have added those words. Id. In
support for its decision, the court cited Public Employees’
Retirement Board v. Shalala, 153 F.3d 1160 (10th Cir. 1998),
which concluded that the term “salary reduction agree-
ment” (as used in another subsection of the Internal
Revenue Code) included mandatory plans. The court also
acknowledged but rejected the University’s argument
that a revenue ruling from 1965 and a treasury regula-
tion in effect prior to 2005 supported its interpretation.
Univ. of Chi., 2007 WL 2409793, at *3. The court declined
to address the University’s analysis of legislative history,
finding that it would be improper where the subsection
was unambiguous. Id. Finally, the court determined that
the University should be liable for a failure-to-deposit
penalty because the obligation to withhold was precise
and not speculative—the University’s failure to deposit
was “at best . . . willful blindness to the plain meaning
of the governing statute.” Id. at *4. Similarly, the court
found that the University should be liable for a failure-to-
pay penalty, despite the University’s argument that
the penalty was inconsistent with the divisible tax
doctrine: “[I]t is one thing to say that a taxpayer need
not pay the total tax in order to gain entry to the court-
house, and quite another to say that the taxpayer may
escape the penalty for failure to timely pay the tax by
filing a lawsuit.” Id.6 No. 07-3686
II. Salary Reduction Agreement
The district court granted the government’s motion
for summary judgment based purely upon a decision of
law, which we review de novo. Officer v. Chase Ins. Life &
Annuity Co., No. 07-2826, 2008 WL 4059780 (7th Cir.
Sept. 3, 2008). The meaning of “salary reduction agree-
ment” is a matter of statutory interpretation, and we
begin by considering the language of the statute. United
States ex rel. Fowler v. Caremark RX, L.L.C., 496 F.3d 730, 738
(7th Cir. 2007). We also consider the context of the provi-
sion because “the meaning—or ambiguity—of certain
words or phrases may only become evident when placed
in context . . . . It is a fundamental canon of statutory
construction that the words of a statute must be read
in their context and with a view to their place in the
overall statutory scheme.” Nat’l Ass’n of Home Builders v.
Defenders of Wildlife, 127 S. Ct. 2518, 2534 (2007) (quoting
FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120,
132 (2000)) (internal quotation marks omitted).
On appeal, the University of Chicago argues that Con-
gress intended the “salary reduction agreement” language
of § 3121(a)(5)(D) to include a salary reduction agree-
ment in the FICA wage base only if the agreement
reflected an employee’s voluntary choice to receive a
lower stated salary plus payments to purchase annuity
contracts in lieu of receiving cash. In addition to dis-
cussing the plain language, the University directs our
attention to revenue rulings, regulations, and the statute’s
legislative history to demonstrate Congressional intent.
The government argues that the proper distinction drawn
No. 07-3686 7
in § 3121(a)(5)(D) is between payments that are salary
reductions as compared to payments that are salary
supplements. As might be expected, the government
provides alternative explanations for the revenue
rulings, regulations, and legislative history relied upon
by the University.
The language of § 3121(a)(5)(D) sets up an exception-to-
the-exception definition of wages. “Wages” includes all
remuneration for employment, except payments “made
to, or on behalf of, an employee or his beneficiary . . .
under or to an annuity contract described in section
403(b).” It excludes those payments for the purchase of
such contracts which are made by reason of salary re-
duction agreements. The University contends that the
plain language supports its interpretation that the agree-
ment must be individually negotiated through an em-
ployee’s voluntary election to receive a lower stated
salary plus payments to purchase annuity contracts. The
use of the term “agreement” requires a choice, it argues.
The University’s employees were not given a choice
because participation in CRP and ERIP was mandatory;
therefore, the payments were not made pursuant to a
salary reduction agreement or subject to FICA tax.
In Public Employees’ Retirement Board, the Tenth
Circuit considered the meaning of “salary reduction
agreement” in a different subsection of § 3121, which
dealt with payments that were treated as employee con-
tributions but had been “picked up” by the local or state
government employers. The “pickups” were mandatory
through a state statute. The Retirement Board made a
8 No. 07-3686
similar argument as the University makes now—that
a salary reduction agreement had to be individually
negotiated and voluntary. The Tenth Circuit held that
“salary reduction agreement” in the context of govern-
ment pickups included mandatory plans—for reasons
we will discuss in more detail later—and it rejected the
Retirement Board’s contention that an agreement had to
be individually negotiated. Public Employees’ Retirement
Board, 153 F.3d at 1165-66. The court cited the Second
Restatement of Contracts and determined that:
[a]n “agreement” is not limited to individually
negotiated contracts . . . but may also refer gener-
ally to a manifestation of mutual assent on the part
of two or more persons. . . . Here, an employee’s
decision to go to work or continue to work as a
State employee constitutes conduct manifesting
assent to a salary reduction in exchange for the
State’s contribution to a pension plan on the em-
ployee’s behalf. The employee has “agreed” to the
salary reduction by continuing employment with
the State.
Id. at 1166 (internal citations omitted). We agree with
our sister circuit that Congress’s use of the word “agree-
ment” in this provision does not foreclose mutual assent
through something other than individual negotiation or
“voluntary” election.3
3
In fact, for several years the University even titled its ERIP
form “Salary Reduction Agreement.” The University explains
(continued...)
No. 07-3686 9
Standing alone, § 3121(a)(5)(D) is more susceptible to
the government’s interpretation that the provision distin-
guishes between a salary supplement, i.e., “any payment
made to, or on behalf of, an employee or his beneficiary . . .
under or to an annuity contract described in section
403(b),” and a salary reduction, i.e., “a payment for the
purchase of such contract which is made by reason of a
salary reduction agreement.” The University’s argument
that the provision refers to voluntary elections does not
rest solely upon the language of § 3121 itself, though.
And so we wade into the murky waters of “context” in
the tax code to look for evidence of the meaning
asserted by the University.
The current version of § 3121(a) was enacted in 1983.
Versions of that section date back to 1939: “The term
‘wages’ means all remuneration for employment . . . except
that such term shall not include . . . [t]he amount of any
payment made to, or on behalf of, an employee under a
plan or system established by an employer . . . (including
any amount paid by an employer for insurance or annu-
ities, or into a fund, to provide for any such payment), on
account of . . . retirement.” Social Security Act Amend-
3
(...continued)
that, for some employees, ERIP was voluntary and so the title
was not a misnomer because of those employees—but the
employees for whom ERIP was mandatory apparently signed
the same form. We attach no legal significance to the title of
the form but merely point it out as an interesting backdrop
to the discussion at hand.
10 No. 07-3686
ments of 1939, ch. 666, § 606, 53 Stat. 1360, 1383 (1939).4
This excluded employer-contributed funds from
taxation under FICA, so as to “eliminate any reluctance
on the part of the employer to establish such plans due
to the additional tax cost.” New England Baptist Hosp. v.
United States, 807 F.2d 280, 283 (1st Cir. 1986) (citing H.R.
Rep. No. 76-728, reprinted in 1939-2 C.B. 538, 542).
In 1965, the IRS issued a revenue ruling responding
to advice sought by an employer as to whether amounts
used to purchase an annuity contract for an employee
under an agreement that reduced the employee’s
salary constituted employer contributions (not subject to
FICA) or employee contributions (subject to FICA). Rev.
Rul. 65-208, 1965-2 C.B.383. The ruling held that the
amounts should be considered employee contributions
and subject to FICA. Id.In 1981, the Supreme Court decided Rowan Companies,
Inc. v. United States, 452 U.S. 247 (1981), which considered
whether the value of meals and lodging for employees
on offshore oil rigs provided for the employer’s conve-
nience should be included in the computation of “wages”
for purposes of FICA and Federal Unemployment Tax
Act (FUTA) tax. The Court looked to comparable sections
in the income tax provisions, as well as treasury regula-
tions and legislative history to determine Congressional
intent. The Court concluded that the plain language and
4
The Internal Revenue Code of 1954 moved the section to 3121,
but the language remained substantially the same until 1983.
See 26 U.S.C. § 3121(a)(2) (1954).
No. 07-3686 11
legislative history indicated that Congress intended
“wages” to be treated in the same manner for purposes
of income taxation and FICA/FUTA taxation. Id. at 263.
The meals and lodging amounts were excluded from
income tax withholding; therefore, the amounts should
also be excluded from FICA and FUTA. Id.After Rowan, there was some doubt about the con-
tinuing validity of the 1965 salary reduction agreement
revenue ruling because amounts paid to purchase annuity
contracts under a salary reduction agreement were in-
cluded in the FICA wage base but were not subject to
income tax withholding. S. Rep. No. 98-23, at 180 (1983).
Subsequently, Congress codified the 1965 revenue ruling
in § 3121. Temple Univ. v. United States, 769 F.2d 126, 131
(3d Cir. 1985). It also added a “decoupling” provision to
make explicit that “[n]othing in the regulations prescribed
for purposes of chapter 24 (relating to income tax with-
holding) which provides an exclusion from ‘wages’ as
used in such chapter shall be construed to require a
similar exclusion from ‘wages’ in the regulations pre-
scribed for purposes of this chapter.” § 3121(a). As previ-
ously noted, Congress expressed a purpose in 1939 to
eliminate employers’ reluctance to establish such plans
due to the additional tax cost; courts have noted that by
1983, the focus had shifted somewhat: “In 1983, Congress
was looking to solidify the social security system in the
face of serious concerns about its solvency. . . .” New
England Baptist Hosp., 807 F.2d at 283. The current
version of § 3121(a)(1)(D) was created at this time.
The University argues that the 1965 revenue ruling
supports its current position. We acknowledge that the
12 No. 07-3686
plan at issue in the ruling was a voluntary salary
reduction agreement, but we disagree with the University
as to the import of that fact. The issue in the ruling was
whether a reduction in an employee’s salary where the
funds were used to purchase annuity contracts for re-
tirement was subject to FICA taxation, even though it
was not subject to income tax withholding. Rev. Rul. 65-
208, 1965-2 C.B. 383. In the ruling, the IRS noted that
the purposes of § 403(b) and § 3121 “are substantially
different. Therefore, a determination under section 403(b)
of the Code that a particular amount is ‘contributed by
the employer’ for the purchase of an annuity contract
does not necessarily require a similar determination that
it is also an amount ‘paid by an employer’ under section
3121(a)(2).” Id. The ruling concluded that the funds
were considered employee-contributed and subject to
FICA tax, even though they were treated as employer-
contributed for purposes of income taxation. Id. The final
paragraph distinguished the ruling from a previous 1953
revenue ruling, which held that an organization that
uses its own funds for the purchase of an annuity contract
is not subject to FICA tax on the amounts of those funds.
Id. The IRS explained that the 1965 ruling covered a
different situation: “where the employee takes a
voluntary reduction in salary to provide the necessary
funds.” Id. While the underlying plan in the ruling was
a voluntary agreement, this was not a point of emphasis
in the ruling—in fact, the word “voluntary” appeared
only once. To the extent that the employee’s degree of
control may have affected the IRS’s distinction between
employee-contributed and employer-contributed funds,
No. 07-3686 13
the ruling simply did not address it; mandatory salary
reductions were certainly not expressly or implicitly
excluded from FICA taxation.5 The government also
notes that the distinction drawn by the ruling and by
§ 3121 is consistent with the original purpose of the
FICA exclusion to eliminate any additional tax cost on the
employer. If the employer did not contribute a salary-
reduced amount to a § 403(b) plan, then the amount
would be used instead to pay the employee’s salary. Both
options would result in the same FICA taxation for the
employer. A salary supplement, on the other hand, would
result in an additional tax cost for the employer, so it
is specially excepted from the definition of “wages.”
The University also directs our attention to former
Treasury Regulation § 31.3121(a)(2)-1(d), in effect from
1956 to 2005. The regulation set out the FICA exclusion
for payments made by an employer to or on behalf of
an employee on account of retirement, sickness, disability,
or death. It elaborated on several points, one of which
stated: “It is immaterial for purposes of this exclusion
whether the amount or possibility of such benefit pay-
ments is taken into consideration in fixing the amount of
an employee’s remuneration or whether such payments
are required, expressly or impliedly, by the contract of
service.” 1956-2 C.B. 605, 625. The government explains
5
The University points out that without employee control or
choice, the distinction between employer-contributed and
employee-contributed funds leads to an arbitrary label, rather
than a functional difference. We address this argument later.
14 No. 07-3686
that the payments “required . . . by the contract of service”
are employer-payments (i.e., salary supplements), and the
provision is merely detailing the rule—which is still in
effect today—that employers do not pay FICA taxes on
contributions to annuity plans for their employees. We
agree. The reference to “fixing the amount of an em-
ployee’s remuneration” is not equivalent to a salary
reduction agreement because the funds contributed are
the employer’s funds. To a certain extent, of course, all
benefits offered to an employee have the indirect effect of
reducing the employee’s salary. But the point of a salary
reduction agreement is that the funds are considered
employee-contributed, which is the principle that was
later explained in the 1965 revenue ruling.
We also consider the cross-references cited by the
University in determining the meaning of § 3121(a)(5)(D).
The Internal Revenue Code currently uses the term “salary
reduction agreement” in only six sections: § 129 (income
taxation of dependent care assistance programs), § 402
(income taxation of employees’ trusts), § 403 (income
taxation of employee annuities), § 414 (special income
taxation rules), § 3121 (FICA definitions), and § 3306
(FUTA definitions). None of the sections provides a
definition of “salary reduction agreement,” although two
sections refer to a “salary reduction agreement (within
the meaning of section 3121(a)(5)(D)).” §§ 402(g)(3)(C);
414(n)(5)(C)(iii)(III). The University points to the former,
§ 402(g)(3)(C), as evidence supporting the meaning it
asserts.
Section 402(g) provides a limitation on the exclusion
from income taxation for elective deferrals. Section
No. 07-3686 15
402(g)(3) defines “elective deferrals” (for purposes of
that subsection) as the sum of certain employer contribu-
tions under other sections of the Code and, under sub-
section (C), “any employer contribution to purchase an
annuity contract under section 403(b) under a salary
reduction agreement (within the meaning of section
3121(a)(5)(D)).” The University asserts that this language
demonstrates that Congress equated salary reduction
agreements with elective deferrals. But § 402(g)(3)(C)
borrows the meaning of salary reduction agreement
from § 3121(a)(5)(D)—§ 402 does not conversely inject
its context into § 3121. The University also contends
that the other types of employer contributions listed in
§ 402(g) are payments that involve a cash-or-deferral
option, which demonstrates that a salary reduction agree-
ment should also be interpreted as it suggests: a voluntary
reduction in salary for purchase of retirement annuities
taken in lieu of cash. However, the University ignores
§ 402(g)’s additional limitation: “An employer contribu-
tion shall not be treated as an elective deferral described
in subparagraph (C) if under the salary reduction agree-
ment such contribution is made pursuant to a one-time
irrevocable election made by the employee at the time
of initial eligibility to participate in the agreement or is
made pursuant to a similar arrangement involving a
one-time irrevocable election specified in regulations.”
Because all salary reduction agreements are not elective
deferrals even within § 402(g) itself, there is no reason to
read § 3121 as encompassing only elective deferrals.
Moreover, the University’s invocation of the nondiscrimi-
nation rules in § 403(b)(12) fails to persuade us for the
16 No. 07-3686
same reason as § 402(g)(3); the provision uses the term
“salary reduction agreement” but further limits and
defines it within the same subsection in the same
manner that § 402(g)(3) did.
As promised, we now return to Public Employees’ Retire-
ment Board to consider how the term “salary reduction
agreement” was used in § 3121(v)(1)(B). At issue in the
case was the FICA tax liability of contributions by em-
ployees to state and local government pension plans that
had been “picked up” by the government employers, as
mandated by state statute. Section 3121(v)(1)(B) states:
“Nothing in any paragraph of subsection (a) . . . shall
exclude from the term ‘wages’ . . . any amount treated as
an employer contribution under section 414(h)(2) where
the pickup referred to in such section is pursuant to a
salary reduction agreement (whether evidenced by a
written instrument or otherwise).” To determine
whether “salary reduction agreement” included mandatory
payments, the court analyzed the corresponding
§ 414(h)(2), and revenue rulings interpreting that section,
to ascertain under what circumstances “pickups” occurred.
Public Employees’ Retirement Board, 153 F.3d at 1163-64.
The court concluded that pickups require: (1) the em-
ployer to specify that the contributions, although desig-
nated as employee contributions, are being paid by the
employer in lieu of employee contributions; and (2) the
employee cannot have the option of receiving the con-
tributed amounts directly instead of having them paid
by the employer to the pension plan. Id. at 1164. Because
the second requirement foreclosed voluntary agreements
as pickups, the term “salary reduction agreement” in
No. 07-3686 17
§ 3121(v)(1)(B) could not coherently exclude mandatory
agreements because the provision would never be impli-
cated. Id. at 1166. Therefore, the court held that the “salary
reduction agreement” provision included mandatory
government pickups as “wages” for FICA purposes. Id.
The University does not point to a flaw in the reasoning
of Public Employees’ Retirement Board; instead, it argues
that, like the Tenth Circuit, we should consider the corre-
sponding section referenced in the subsection at issue—
here § 403(b)—to determine the proper context for “salary
reduction agreement.” If we assumed that the meaning
of “salary reduction agreement” as used throughout the
Code generally encompasses both voluntary and manda-
tory agreements, then we agree with the University’s
premise that we could reach the opposite conclusion of
Public Employees’ Retirement Board without necessarily
creating a circuit split—the Tenth Circuit found that
§ 414(h) implicates only mandatory agreements, so we
could find that § 403(b) implicates only voluntary agree-
ments. We do not find, however, that § 403(b) requires
us to read that limitation into § 3121(a)(5)(D). Without
support for that limitation, the sensible approach, which
is consistent with basic rules of statutory construction,
would be for us to conclude that § 3121(a)(5)(D), like
§ 3121(v)(1)(B), includes mandatory salary reduction
agreements. See Arnett v. Comm’r of Internal Revenue, 473
F.3d 790, 798 (7th Cir. 2007) (citing Comm’r of Internal
Revenue v. Lundy, 516 U.S. 235, 250 (1996)) (applying
the “normal rule of statutory construction that identical
words used in different parts of the same act are
intended to have the same meaning” (internal quotation
18 No. 07-3686
marks omitted)); In re Willett, No. 07-1850, 2008 WL
4182649, at *4 (7th Cir. Sept. 12, 2008) (“Courts are
obliged to read statutory provisions at issue in such a
way as to avoid a conflict between them if such a con-
struction is possible and reasonable.”); Square D Co. &
Subsidiaries v. Comm’r of Internal Revenue, 438 F.3d 739, 745
(7th Cir. 2006) (citing Alaska Dep’t of Envtl. Conservation v.
EPA, 540 U.S. 461, 489 n.13 (2004)) (noting the “cardinal
principle of statutory construction” that, if possible, a
statute should not be construed to render another “clause,
sentence, or word . . . superfluous, void, or insignificant”).
Finally, the University argues that the government’s
position unnecessarily elevates form over substance;
whereas, the University’s interpretation offers a
functional, substantive approach. The University explains
that the government’s interpretation emphasizes the
form of the payments—did the University characterize
the payments as a higher stated salary minus a man-
datory employee-paid annuity contribution or a lower
stated salary plus a larger employer-paid annuity con-
tribution? That form, it argues, is of no economic signifi-
cance. If the employer mandates a “contribution” of 5%
from an employee’s salary and contributes an additional
amount equal to 7.5% of the employee’s salary, the
money used for both contributions comes directly from
the same source (the University). It makes no difference
how that money is characterized. In the context of
income taxation, we have previously recognized this
argument, noting that the distinction between employer-
contributed funds and employee-contributed funds is
“almost wholly nominal.” Howell v. United States, 775
No. 07-3686 19
F.2d 887, 887 (7th Cir. 1985). “It is a matter of indifference
to an employer whether it pays $30,000 salary to the
employee plus $3,000 to a pension plan on the em-
ployee’s behalf, or instead $33,000 to the employee, of
which it sends $3,000 to a pension plan. In either event
the employee receives $30,000 at once and $3,000 in
deferred compensation, and the employer may deduct
the whole $33,000 as an ordinary and necessary business
expense.” Id. Therefore, the University urges us to adopt
its “functional” distinction between mandatory and
voluntary salary reduction agreements: an employee has
“wages” if she could choose to receive an amount in
cash but instead directs it to an annuity, and she does not
have “wages” if the employer makes a mandatory
annuity payment with no cash option.
The distinction between employee-contributed funds
and employer-contributed funds might be “nominal” from
the employer’s perspective, but the difference neverthe-
less could be significant to the employee. The govern-
ment responds to the University’s form-over-substance
argument by pointing out one purported economic dis-
tinction: employee-contributed funds count for purposes
of Social Security benefits and employer-contributed
funds do not; therefore, a salary reduction would result
in higher Social Security benefits. The error in this argu-
ment is apparent, however, when 42 U.S.C. § 409(a)(4)(E)
is consulted. For purposes of calculating Social Security
benefits, the term “wages” is defined generally as all
remuneration except payments “under or to an annuity
contract described in section 403(b) of the Internal
Revenue Code of 1986, other than a payment for the
20 No. 07-3686
purchase of such contract which is made by reason of a
salary reduction agreement (whether evidenced by a
written instrument or otherwise).” Salary reduction
agreements, therefore, only count for Social Security-
benefits purposes if they counted for FICA-taxation pur-
poses. This circular argument adds nothing to the form-
over-substance debate. Although not discussed by the
parties, one potential economic distinction where the
labeling of the source of the funds would matter to
both parties is the vesting of contributions. If a plan
provided for employer-contributed funds that were not
immediately fully vested, both parties would be
impacted if the employee left her employment prior to the
expiration of the vesting period. Employer-contributed
funds would be returned to the employer according to
its vesting schedule, while employee-contributed funds
would remain with the employee. It appears that
employer-contributed funds in CRP and ERIP were
immediately fully vested, so this distinction is of no
significance to the University or its employees; however,
it illustrates that the position favored by the government
is not entirely “form over substance” in all situations.
We need not explore any other scenarios looking for
economic distinctions, though, because the objective of
statutory construction is to carry out Congressional
intent, even if that intent is to promote form over sub-
stance. We noted in Howell that the distinction between
employer and employee contributions was merely “one
example of the dominance of form over substance in the
tax code,” and we applied the formal distinction in that
case. Howell, 775 F.2d at 887-890. We conclude that Con-
No. 07-3686 21
gress intended § 3121(a)(5)(D) to include “salary reduction
agreements,” whether voluntary or mandatory, in the
FICA wage base. As noted before, the plain language of
the statute demonstrates that the provision distinguishes
between a salary supplement, i.e., “any payment made to,
or on behalf of, an employee or his beneficiary . . . under
or to an annuity contract described in section 403(b),” and
a salary reduction, i.e., “a payment for the purchase of
such contract which is made by reason of a salary reduc-
tion agreement.” Nothing in the context provided by
the University convinces us that Congress intended a
“salary reduction agreement” to apply solely to situ-
ations in which an employee voluntarily chose to receive
a lower stated salary plus payments to purchase
annuity contracts in lieu of receiving cash.6
III. Penalties
Half of the IRS’s assessment against the University
represents amounts that the University failed to
6
Because we have concluded that the language and context of
the provision do not support the University’s arguments, we
will not delve into the University’s analysis of the legislative
history. Nonetheless, though some of the language in the
legislative history cited by the University indeed references
voluntary agreements, see, e.g., H.R. Rep. No. 98-47, at 437 (1983)
(Conf. Rep.), none purports to exclude mandatory agreements,
and a Senate Report expressly disclaims its intention to desig-
nate whether an amount was made by reason of a salary
reduction agreement. S. Rep. No. 98-23, at 182 (1983).
22 No. 07-3686
withhold from its employees; this aspect of the appeal
requires us to determine whether the University should
be liable for those amounts. Under § 3102(b), an employer
is primarily liable for payment of the taxes that it is
required to deduct and withhold from the employee. The
University asserts the so-called “deputy tax collector”
defense, which excuses an employer from withholding
employment taxes from its employees unless the oblig-
ation to withhold was “precise and not speculative.”
North Dakota St. Univ. v. United States, 255 F.3d 599, 608
(8th Cir. 2001) (citing Cent. Ill. Pub. Serv. Co. v. United States,
435 U.S. 21, 31 (1978)). As the taxpayer, it is the Univer-
sity’s burden to show that it did not have sufficient
notice of its obligation to withhold. See Am. Airlines, Inc. v.
United States, 204 F.3d 1103, 1108 (Fed. Cir. 2000). If suc-
cessfully asserted, the defense would excuse the
University from paying only the employees’ half of the
tax liability. North Dakota St. Univ., 255 F.3d at 608.
The University claims that its obligation to withhold
was speculative and not precise in 2000-2003 because
there were no judicial decisions, regulations, or rulings
that would have given the University notice of this ob-
ligation. We disagree. Since 1983, the plain language of
§ 3121(a)(5)(D) indicated that salary supplements paid
by the employer are not included in the FICA wage base
but salary reductions are included. To the extent that
the use of the word “agreement” might have implied a
requirement of voluntariness, the Tenth Circuit rejected
that argument in 1998. Public Employees’ Retirement Board,
153 F.3d at 1166. Further, the courts that have construed
the 1965 revenue ruling have characterized its holding
No. 07-3686 23
as distinguishing between salary reductions and salary
supplements for FICA purposes. See New England Baptist
Hosp., 807 F.2d at 282; Carnisius Coll. v. United States, 799
F.2d 18, 21 (2d Cir. 1986); Temple Univ., 769 F.2d at 129-30.
No court has suggested that the ruling drew an addi-
tional line between mandatory and voluntary agreements.
Therefore, we conclude that the district court properly
determined that the University’s obligation was precise
and not speculative. Cf. Cent. Ill. Pub. Serv. Co., 435 U.S. at
25-26, 33 (excusing income tax withholding obligation
for employee lunch reimbursements where the Internal
Revenue Code and regulations did not require it, the
Courts of Appeals had been in “disarray” on the issue,
and regulations implied that reimbursements were not
subject to withholding); H B & R, Inc. v. United States,
229 F.3d 688, 692 (8th Cir. 2000) (excusing FICA tax with-
holding for certain travel expenses where income taxation
withholding was required but no case or regulation had
ever required FICA withholding for expenses of that
kind).7
7
The University points to a 2004 temporary regulation, which
was finalized in 2007, that explicitly states that salary reduction
agreements include agreements made as a condition of em-
ployment. Treas. Reg. § 31.3121(a)(5)-2. This does not assist
the University in demonstrating that its obligation to with-
hold was not precise during the 2000-2003 tax years, however,
because the regulation did not effect a change in policy. It was
promulgated at the same time as temporary and proposed
income tax regulations that created a new special rule for
(continued...)
24 No. 07-3686
The IRS also imposed upon the University failure-to-
deposit and failure-to-pay penalties. Failure-to-deposit
penalties are imposed for a failure to deposit amounts
as required by the Internal Revenue Code or regulation.
26 U.S.C. § 6656. Failure-to-pay penalties are imposed
for a failure to pay an amount required to be shown on
a tax return or failure to pay an assessment within the
requisite time frame. Id. § 6651(a)(3). Both penalties are
mandatory unless the taxpayer shows that “the failure
is due to reasonable cause and not due to willful neglect.”
Id. §§ 6651, 6656; see also Diamond Plating, 390 F.3d at 1038.
We review a determination of the elements required to
prove “willful neglect” or “reasonable cause” de novo,
but the presence or absence of those elements in this case
is a question of fact which we review for clear error.
See East Wind Indus., Inc. v. United States, 196 F.3d 499,
504 (3d Cir. 1999) (citing United States v. Boyle, 469 U.S.
241, 249 n.8 (1985)).
“Willful neglect” and “reasonable cause” are not defined
terms within the Internal Revenue Code. The Supreme
Court has construed “willful neglect” as a conscious,
intentional failure or reckless indifference. Boyle, 469 U.S.
at 245. “Reasonable cause” with respect to a failure to
pay is defined through a Treasury Regulation and mea-
7
(...continued)
mandatory salary reduction contributions, and its purpose
was to make explicit the FICA treatment of such agreements,
notwithstanding the new regulations for income taxation. See
69 Fed. Reg. 67054, 67075.
No. 07-3686 25
sured by “the extent that the taxpayer has made a satis-
factory showing that he exercised ordinary business
care and prudence in providing for payment of his tax
liability and was nevertheless either unable to pay the tax
or would suffer an undue hardship . . . if he paid on the
due date.” In re Carlson, 126 F.3d 915, 921 (7th Cir. 1997)
(citing 26 C.F.R. § 301.6651-1(c)(1)). The taxpayer faces a
“heavy burden” to show that it exercised ordinary
business care and prudence. Richardson v. Comm’r of
Internal Revenue, 125 F.3d 551, 557 (7th Cir. 1997) (citing
Boyle, 469 U.S. at 689-90). There is no similar regulation
defining “reasonable cause” for a failure to deposit (al-
though there is an exception for first-time depositors,
which is not applicable here). See 26 C.F.R. § 301.6656-1(a).
The University’s sole argument is that its failure to
deposit was due to a “cogent interpretation” of the law.
The University’s interpretation was unsupported and
unreasonable; therefore, we agree with the district court’s
conclusion that the University has not sustained its
heavy burden in showing that its failure to deposit was
due to reasonable cause.
Finally, the University argues that the IRS should not
have imposed failure-to-pay penalties for its failure to
pay the assessments because the University paid
divisible portions in order to institute a refund suit. As a
general rule, to challenge an assessment in a district court,
a taxpayer must pay the full amount of the assessed tax
and then pursue a refund. Flora v. United States, 362
U.S. 145, 177 (1960) (Flora II); Ruth v. United States, 823
F.2d 1091, 1093 (7th Cir. 1987). Full payment is a juris-
dictional prerequisite imposed by Congress. See Flora v.
26 No. 07-3686
United States, 357 U.S. 63, 64-65, 75 (1958) (Flora I), aff’d on
reh’g, Flora II, 362 U.S. at 177. Where a tax is “divisible,”
however, “the taxpayer may pay the full amount on one
transaction, sue for a refund for that transaction, and have
the outcome of this suit determine his liability for all the
other, similar transactions.” Korobkin v. United States, 988
F.2d 975, 976 (9th Cir. 1993) (per curiam); Ruth, 823 F.2d
at 1093. The government will usually bring a counter-
claim for the remainder of the tax due. Ruth, 823 F.2d at
1093. Employment taxes are considered divisible taxes.
Boyd v. Comm’r of Internal Revenue, 451 F.3d 8, 12 (1st Cir.
2006); Korobkin, 988 F.2d at 976.
The University argues that the “divisible tax doctrine”
is incompatible with a failure-to-pay penalty and would
potentially subject taxpayers to substantial penalties for
challenging the assessment. It notes that a taxpayer
who does not prevail in the refund suit is still subject to
statutory interest, so the government would be fully
compensated for the delay in payment. The University
also points out that where a taxpayer has paid a divisible
amount of an assessment, the government is precluded
from levying on a taxpayer’s property to collect
unpaid portions pending resolution of the proceedings.
26 U.S.C. § 6331(I).
We recognize the University’s concern that the
divisible tax doctrine allows a taxpayer to gain access to
the court to challenge an assessment but potentially
penalizes the taxpayer who does not prevail. Statutory
interest alone might be enough to compensate the gov-
ernment for the delay, as well as to deter frivolous chal-
No. 07-3686 27
lenges without discouraging legitimate ones—but this
was not the policy chosen by Congress. Failure-to-pay
penalties are mandatory unless due to reasonable cause
and not due to willful neglect. Id. § 6651(a)(3). The divisible
tax doctrine is merely a jurisdictional tool to challenge
an assessment in the district court. Korobkin, 988 F.2d at
976. Congress chose to protect taxpayers who had unpaid
divisible portions from levy by the government while a
refund suit was pending, § 6331(i), and though it could
have made a similar choice for failure-to-pay penalties,
it did not. The IRS properly imposed failure-to-pay penal-
ties on the University.
IV. Conclusion
We AFFIRM the district court’s decision that the IRS
properly assessed the University of Chicago for FICA taxes
for contributions made pursuant to salary reduction
agreements under ERIP and CRP. We also AFFIRM the
court’s determination that the University is liable for
failure-to-deposit and failure-to-pay penalties.
10-29-08