U n i t e d S t a t e s G o v e r n m e n t FORM 0.1151(1-92)

R a i l r o a d R e t i r e m e n t B o a r d MEMORANDUM

March 21,2002

L-2002-04

TO: James A. Verplaetse

Chief of Payment Analysis and Systems

FROM: Steven A.

General C

SUBJECT: Federal Tax Reports for Penalty Deductions

This is in reply to your inquiry of February 5, 2002, requesting my advice as to

whether penalty deductions assessed against annuitants under the Railroad

Retirement Act (RRA) for failure to make timely excess earnings reports may be

included as repayments for purposes of the agency’s obligations under the

Internal Revenue Code. For the reasons discussed below, I find that these

deductions may be reported as repayments.

Your memorandum states that since May 1995, penalties have been combined

with the underlying erroneous payment amount in agency receivables

accounting, and have not been segregated for recovery purposes from the

erroneous annuity payment caused by the claimant’s earnings. As a result, when

the annuitant repays the erroneous payment amount (whether by cash refund,

offset in monthly annuities, or actuarial adjustment in future annuities), the

penalty amount is included as annuities “repaid” for purposes of the Board’s

reporting responsibilities under the Internal Revenue Code. Your memorandum

suggests first, that late report penalties should not be considered erroneous

benefit payments in the same sense as the underlying annuity deduction fo r.

earnings; and second, that you believe collection of a penalty is not a

“repayment” within the meaning of the Code, and hence should be reported

differently under the relevant Code provisions.

With respect to the initial question, I note that penalty deductions for untimely
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earnings reports in non-disability1cases derive from four separate provisions of

the Railroad Retirement Act.2 Pursuant to section 2(f)(1) of the Act, certain

components of an employee age and service annuity:

* * * shall be subject to deductions on account of work pursuant to the

provisions of section 203 of the Social Security Act in the same manner

as if such portion of such annuity were a monthly insurance benefit under

that Act * * * . Any person in receipt of an annuity subject to deduction

under this subsection shall report to the Board the receipt of excess

earnings as defined in paragraph (3) of section 203(f) of the Social

Security Act.

Section 2(f)(2) of the RRA further states that certain components of spouse and

divorced spouse annuities:

shall be subject to deductions on account of work pursuant to the

provisions of section 203 of the Social Security Act in the same manner as

if such portion of such spouse's annuity were a monthly insurance benefit

under that Act.

Annuity deductions for the earnings of survivor annuitants are set forth at section

2(g)(2) of the RRA in pertinent part as follows:

(2) Deductions, in amounts and at such time or times as the Board shall

determine, shall be made from any payments to which a survivor is

entitled under subsection (d) until the total of such deductions equals such

survivor's annuity under that subdivision for any month, if for such month

such survivor would be charged with excess earnings under section 203(f)

of the Social Security Act * * * For purposes of this subdivision, the Board

shall have the authority to take such actions and to make such

determinations and such suspensions of payment of benefits in the

manner and to the extent that the Secretary of Health and Human

1 Section 2(e)(4) of the RRA requires disability annuitants who earn more than

$400 in a month to report to the Board any such payment of earnings for such

employment or self-employment before the receipt and acceptance of an annuity

for the second month following the month of such payment, and imposes an

additional deduction in the annuity of an employee who fails to make such report.

The deductions pursuant to section 2(e)(4) are not the subject of your inquiry,

and are not addressed by this memorandum.

2 Although deductions may also be imposed against certain annuity components

for continuation in last person employment pursuant to section 2(e)(6), no

additional deductions are specified for untimely reporting of such employment.
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Services would be authorized to take or to make under section 203(h)(3)

of the Social Security Act.

Employee annuities (and the annuities of spouses, where applicable) are also

subject to deductions for excess earnings when paid under the social security

over-all minimum guaranty provision (section 3(f)(2)) of the RRA, which limits the

increase only to:

* * * the total amount * * * which would have been payable to all persons

for such month under the Social Security Act if such individual's service as

an employee after December 31,1936, were included in the term

‘'employment" as defined in that Act * * *.

The foregoing provisions of the RRA all incorporate, directly or inferentially,

section 203 of the Social Security Act (42 U.S.C. 403), which specifies the

method by which monthly benefits of the insured beneficiary and family members

are reduced for certain events, including earnings. Insofar as is relevant here,

section 203(b) establishes the deduction for earnings; section 203(f) defines

earnings to be charged against monthly benefits, including calculation of

earnings exceeding the annual maximum; section 203(h)(1) establishes the

beneficiary’s reporting duties; and section 203(h)(2) imposes additional benefit

deductions for late reporting of earnings, as follows:

(h)(2) If an individual fails to make a report required under paragraph (1) of

this subsection, within the time prescribed by or in accordance with such

paragraph, for any taxable year and any deduction is imposed under

subsection (b) of this section by reason of his earnings for such year, he

shall suffer additional deductions as follows:

(A) if such failure is the first one with respect to which an additional

deduction is imposed under this paragraph, such additional deduction

shall be equal to his benefit * * * for the last month of such year for

which he was entitled to a benefit, ***except * * * [if less than a full

month was withheld under 203(b) for excess earnings for the last

month, then] the additional deduction shall be equal to the amount of

the deduction imposed under subsection (b) of this section but not less

than $10;

(B) if such failure is the second one * * * such additional deduction shall be

equal to two times his benefit * * * for the last month of such year * * *;

(C)if such failure is the third or a subsequent one * * * such additional

deduction shall be equal to three times his benefit * * * for the last

month of such year * * *;
James A. Verplaetse

In January 1995, the former Director of Retirement and Survivor Programs

informed this office that in recovering the penalty deductions in employee and

spouse annuities imposed by section 2(f) of the RRA,

It has long been RRB policy that penalty deduction amounts are not

considered to be overpayments in the strictest definition of

"overpayments” and, therefore, are not entered on the program accounts

receivable (PAR) [computerized debt tracking] system. It has also been

RRB policy to suspend the annuity to recover the penalty * * * and then

recover the overpayment [by the means selected by the annuitant], SSA

adds the penalty deduction amount into the overpayment and recovers the

entire amount (penalty and overpayment) following their standard recovery

procedures. If [recovery by] partial withholding is requested [by the

beneficiary], SSA applies that [recovery by] partial withholding to the

penalty as well.

In Legal Opinion L-95-7, the General Counsel advised the Director that in view of

the language of section 2(f) of the RRA that retirement annuities shall be “subject

to deductions on account of work pursuant to the provisions of section 203 of the

Social Security Act in the same manner” as benefits paid under that Act, no legal

objection existed to prevent revision of the Board’s procedure to correspond with

that of the Social Security Administration. The first question raised by your

current memorandum is whether the advice provided by L-95-7 is correct.

My review of the matter leads me to conclude that L-95-7 reached the correct

conclusion under the law. Legal Opinion L-95-7 approved a change in

administration of the RRA based upon an interpretation of a parallel provision of

the Social Security Act by the SSA. Of course, deductions for earnings applied to

retirement annuities under section 2(f), as well as deductions applied to survivor

annuities under section 2(g)(2) and to annuities increased under the social

security minimum guaranty provision of section 3(f)(2), can only be made

pursuant to Board’s authority to administer the benefit provisions of the Railroad

Retirement Act. See section 7(b) of the RRA. Decisions made by the Social

Security Administration (SSA) in the course of that agency's duty to administer

the Social Security Act cannot supplant the Board's duty under section 7(b),

since the SSA has no authority with regard to benefit decisions under the RRA.

However, where Congress has explicitly borrowed from the Social Security Act in

a provision of the RRA, and where no other provision of the RRA manifests any

Congressional intention to have the two Acts diverge, the Acts should be

interpreted symmetrically. McCov v. Railroad Retirement Board. 935 F. 2d 87,

(5th Cir., 1991) at 88 (holding that the tier I component of a disability annuitant

under the RRA must be reduced for a worker’s compensation benefit as provided

by section 224(a) of the Social Security Act). It has been stated that to have the

two agencies look at the same set of facts under the same rules but arrive at
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contrary decisions creates a public image of unfairness and conflict within the

government. Sones v. United States Railroad Retirement Board. 933 F. 2d 636,

(8th Cir., 1991), at 637. In a determination by the Board of the meaning of the

parallel provision of the RRA, the interpretation of the Social Security Act by the

SSA is therefore entitled to deference. Social Security Board v. Nierotko. 327

U.S. 358 (1945), at 366-367. In particular, the language of the survivor annuity

earnings deduction provision has been held to be jn pan materia with section 203

of the Social Security Act. Linguist v. Bowen. 813 F. 2d 884, (8m Cir., 1987), at

889.

There is no information regarding the basis for the SSA’s interpretation of section

203(h). However, I note that although the term “penalty" is used in the SSA's

regulation regarding failure to timely report earnings (20 CFR 404.453), the

statute itself merely characterizes the deduction for late earnings reports as a

“deduction". Given the language of the Social Security Act, I cannot say that the

SSA wrongly interpreted the additional deductions required by untimely earnings

reports to be a portion of the erroneous payment. Legal Opinion L-95-7 therefore

correctly advised deductions for untimely earnings reports imposed pursuant to

section 2(f) of the RRA may be accounted for and recovered in the same fashion

as late report deductions under section 203(h) of the Social Security Act.

Moreover, in my opinion this analysis applies with equal force to deductions for

late earnings reports imposed under sections 2(g)(2) and 3(f)(2) of the RRA as

well.

The second question posed by your memorandum is whether, even if the penalty

and erroneous payments may be combined in the Board’s receivables

accounting system and for purposes of recovering the payments from the

annuitant, the penalty nevertheless must be segregated for purposes of

statements to the annuitant and returns to the Internal Revenue Service. Since

the methods whereby annuities under the RRA may be included as taxable

income to the annuitant are specified by two disparate sections of the Internal

Revenue Code, you also inquire whether the law allows the same treatment of

late filing penalty deductions under both.

As you know, section 86 of the Code (26 U.S.C. 86) provides that a “tier I railroad

retirement benefit” is subject to taxation on the same basis as are benefits under

the Social Security Act. See section 86(d)(1) of the Code (26 U.S.C. 86(d)(1)).

The “tier I” for purposes of section 86 is defined as the “social security

equivalent" portion of the tier I annuity component and any monthly annuity paid

under the social security minimum guaranty provision of the RRA (RRA section

3(f)(2)). See section 86(d)(4) of the Code. Section 86(d)(2) of the Code further

provides:
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(2) Adjustment for repayments during year. (A) In general. For

purposes of this section the amount of social security benefits received

during any taxable year shall be reduced by any repayment made by the

taxpayer during the taxable year of a social security benefit previously

received by the taxpayer (whether or not such benefit was received during

the taxable year.)

(B) Denial of deduction. If (but for this subparagraph) any portion of

the repayments referred to in subparagraph (A) would have been

allowable as a deduction for the taxable year under section 165, such

portion shall be allowable as a deduction only to the extent it exceeds the

social security benefits received by the taxpayer during the taxable year

(and not repaid during such taxable year).

Code section 6050F(a)(1) (26 U.S.C. 6050F(a)(1)) imposes upon the Board a

duty to file with the IRS a return for social security equivalent benefits which sets

forth the “(A) aggregate amount of social security benefits paid with respect to

any individual during any calendar year,[and] (B) aggregate amount of social

security benefits repaid by such individual during such calendar year * * \ "

Subsection 6050F(b)(2) further requires that the Board “ * * * shall furnish to each

individual [annuitant] * * * a written statement showing * * * the aggregate

amount of payments, of repayments, and of reductions" for the taxable year. The

Board thus has a duty to provide the annuitants with information necessary to file

a return of income taxable under section 86 of the Code, and to apprise the IRS

of information necessary to audit the accuracy of the taxpayer’s return.

Legal Opinion L-95-7 addressed only the issue of recovery of the late report

deduction from the annuitant and related internal agency accounting. Information

was not provided to the General Counsel at that time regarding the

corresponding reporting of the additional deduction for Federal tax purposes.

Further, your memorandum does not state whether the SSA has modified its

returns and statements under IRC section 6050F to accord with its recovery

methods. Even assuming that is the case, the interpretation of the Code by the

SSA is not due the same deference as is that agency’s interpretation of it’s own

statute. See: Adams Fruit Co. v. Barrett. 494 U.S. 638,649 (1990)(congressional

delegation of administrative authority is a precondition to deference to agency's

interpretation of law). For this reason, this office advised the former Director of

Taxation in Legal Opinion L-91-99 that “there is no requirement that the

computation of the SSEB amount conform in every way to the procedures of the

SSA * * * ■ Nevertheless, given the identical definition of SSEB and social

security benefit under the Code, and the bias of the law in favor of uniform

application of the RRA and the Social Security Act, there is certainly no legal

objection which prevents the Board from conforming performance of its
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responsibilities under the Code regarding SSEB amounts to the methods

adopted by the SSA, where the SSA is not clearly incorrect.

In this regard, the suggestion in your memorandum that SSA’s interpretation is

incorrect because a taxpayer cannot net a penalty against benefits paid under

section 86(d)(2) of the Code in the same manner as the taxpayer could net a

repayment of benefits is not without merit. For example, section 162(f) of the

Code (26 U.S.C. 162(f)) explicitly states that ordinary and necessary expenses

incurred in a trade or business shall not include “any fine or similar penalty paid

to a government for a violation of any law." See also, regulations of the Treasury

at 26 CFR 1.162-21. Where no specific tax legislation or Treasury regulation

precludes a deduction, it is well settled that a deduction will be denied where

allowance would frustrate a sharply defined national policy proscribing a

particular form of conduct and evidenced by some governmental declaration of it.

See: Annotation, Modem Status of Rule Dealing with Public Policy as Ground for

Denying Deduction for Federal Income Tax Purposes, 16 L. Ed.2d 1117,(1967)

at 1120.

Section 86(d)(2)(B), quoted above, states that a taxpayer may claim a deduction

under section 165 of the Code in a year where the amount of repayment of a

social security benefit (or SSEB) is greater than the total benefits received in a

taxable year. Section 165(c)(2) (26 U.S.C. 165(c)(2)) allows individual taxpayers

to claim a loss “incurred in any transaction entered into for profit, though not

connected with a trade or business". As section 165 has no provision excluding

penalties per se, whether an item may not be deducted must be determined

under the general public policy rule. However, making a payment to a

government for a violation of law may not automatically mean the payment

constitutes a non-deductible penalty. See: Annotation, Income tax: Deductibility

of Amount Paid or Expense Incurred by Taxpayer on Account of His Liability or

Alleged Liability for Tort, Crime, or Statutory Violation, 20 A.L. R. 2d 600 (1951),

at 606. In particular, it has been said that an exception may be available for “late

filing or interest charges" imposed “to encourage prompt compliance with filing or

other requirements”. Colt Industries v. United States. 880 F. 2d 1311, (Fed. Cir.,

1989) at 1313, (discussing the legislative history of section 162(f)).

Based on the foregoing, I cannot say that a decision of the SSA to include in its

section 6050F return and statement any late filing deduction paid by a beneficiary

as a deductible “repayment" is incorrect. There is consequently no legal objection

to the Board doing so with respect to its duties under 6050F as well.

The last question raised by your memorandum is whether the Board’s duties

under the Code regarding late earnings report penalties may differ with respect to

the remaining, “non-social security equivalent benefit" (non-SSEB) portion of

annuities under the RRA. As you know, section 72(r) of the Code (26 U.S.C.

72(r)) provides that the remaining portion of an annuity under the RRA shall be
James A. Verplaetse

income to the employee to the same extent as a private pension under an

employer plan. That section does not include a provision for allocating

repayments comparable to 86(d)(2). Further, section 6050G(a)(1) of the Code

(26 U.S.C. 6050G(a)(1)) requires the Board to file a return to the IRS showing

th e aggregate amount of benefits paid under the Railroad Retirement Act of

1974 (other than [social security equivalent] * * * benefits * * * ) to any individual

during any calendar year”. Section 6050G(b) directs the Board to furnish

annuitants with a written statement showing th e aggregate amount of payments

to such individual, and of employee contributions with respect thereto, required to

be shown on the return".

This office has previously considered the absence from section 6050G of the

requirement to report aggregate repayments as well as aggregate amounts paid.

Legal Opinion L-94-38 specifically advised that “In view of the absence of the

word “repayment" in section 6050G as well as the absence of a netting rule in

section 72(r) * * * there would appear to be no requirement to report repayments

under section 6050G.” See also Legal Opinion L-2002-2 (concerning repayment

of annuities paid in prior years which are rendered erroneous due to later

cancellation of the annuity application). However, while the Board has no duty

under 6050G to report repayments, neither is it prohibited from supplying this

information. See Legal Opinion L-94-35 (the Board may provide statement to

estate under 6050G of non-SSEB repayment to facilitate estate’s determination

of decedent's income and estate tax liabilities). For the reasons discussed above

with respect to reports of SSEB amounts under 6050F, I therefore find no legal

objection to including in the amount of recovered annuities any deductions for

untimely earnings reports pursuant to sections 2(f) and 2(g)(2) of the RRA, in

returns and statements issued under section 6050G of the Internal Revenue

Code.

cc: Director of Policy and Systems

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