[Federal Register Volume 70, Number 47 (Friday, March 11, 2005)]
[Proposed Rules]
[Pages 12164-12166]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-4382]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[REG-160315-03]
RIN 1545-BC89


Sickness or Accident Disability Payments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding the treatment of payments made on account of 
sickness or accident disability under a workers' compensation law for 
purposes of the Federal Insurance Contributions Act (FICA).

DATES: Written and electronic comments must be received by June 9, 
2005.

ADDRESSES: Send submissions to: CC: PA:LPD: PR (REG-160315-03), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
160315-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayer may submit 
comments electronically, via the IRS Internet site at http://www.irs.gov/regs or via Federal Rulemaking Portal at http://www.regulations.gov (IRS and REG-160315-03).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
David Ford of the Office of Division Counsel/Associate Chief Counsel 
(Tax Exempt and Government Entities), (202) 622-6040; concerning 
submissions of comments, the hearing and/or to be placed on the 
building access list to attend the hearing, LaNita M. VanDyke, (202) 
622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to 26 CFR part 31 under 
section 3121 of the Internal Revenue Code (the Code.) Section 
3121(a)(2)(A) of the Code excepts from ``wages'' for FICA tax purposes 
payments to an employee or any of his dependents on account of sickness 
or accident disability only if the payments are received under a 
``workmen's compensation law'', hereinafter referred to as a workers'' 
compensation law. The amendment to the regulations provides that for 
purposes of section 3121(a)(2)(A) a workers' compensation law includes 
a statute in the nature of a workers' compensation act.

Explanation of Provisions

Current Law

    Section 3121(a) defines wages for FICA purposes as all remuneration 
for employment unless specifically excepted. Section 3121(a)(2)(A) 
excepts from wages the amount of any payment (including any amount paid 
by an employer for insurance or annuities, or into a fund, to provide 
for any such payment) made to or on behalf of, an employee or any of 
his dependents under a plan or system established by an employer which 
makes provision for his employees generally (or for his employees 
generally and their dependents) or for a class or classes of his 
employees (or for a class or classes of his employees and their 
dependents), on account of sickness or accident disability, but only if 
the employee receives the payments under a workers' compensation law. 
Section 3121(a)(4) provides that wages does not include any payment on 
account of sickness or accident disability made by an employer to or on 
behalf of an employee after the expiration of 6 calendar months 
following the last calendar month in which the employee worked for the 
employer. Thus, unless made under a workers' compensation law, payments 
received on account of sickness or accident disability are wages 
subject to FICA during the first 6 months the employee is out of work.
    Prior to its amendment by section 3(b)(1) of Public Law 97-123, (95 
Stat. 1659 1982-6 I.R.B. 7)) (the 1981 Act), section 3121(a)(2)(B), the 
predecessor to section 3121(a)(2)(A), excluded from wages any payments 
made under a plan or system established by an employer on account of 
sickness or accident disability. There was no requirement that payments 
be made under a workers' compensation law. Thus, the 1981 Act narrowed 
the sick pay exclusion by limiting the exclusion from FICA to payments 
made under a worker's compensation law. Section 3(e) of the 1981 Act 
did not amend the Code, but specifies for purposes of section 3121(a) 
of the Code that a payment under a workers' compensation law does not 
include a payment made pursuant to a State temporary disability 
insurance law.
    On July 6, 1982, the IRS issued Temporary regulations (TD 7823, 47 
FR 29225, July 6, 1982). Section 32.1(a)(1) of the Temporary Employment 
Tax Regulations follows the amendments made by the 1981 Act providing 
that payments on account of sickness or accident disability are 
excluded from wages for FICA purposes only if paid under a workers' 
compensation law. Section 32.1(a)(1). Further, Section 32.1(c) provides 
that a payment under a workers' compensation law does not include a 
payment made pursuant to a State temporary disability insurance law. 
Thus, such payments are wages for FICA purposes. The temporary 
regulations do not address the FICA tax treatment of payments made 
under a statute in the nature of a workers' compensation act.\1\
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    \1\ To provide guidance relating to changes made by the Act the 
IRS published Revenue Procedure 82-20 (1982-1 C.B. 466), which 
provided in Q&A 1 that payments under a statute in the nature of a 
workers' compensation act were excluded from FICA. Rev. Proc 82-20 
was obsoleted by Revenue Procedure 95-43 (1995-2 C.B. 412), which 
provides that the temporary regulations generally restate the 
guidance in Q&A-1 through Q&A-9 of Rev. Proc. 82-20.
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    For income tax purposes, section 104(a)(1) provides that gross 
income does not include amounts received under workers' compensation 
acts as compensation for personal injuries or sickness. Section 1.104-
1(b) of the Income Tax Regulations states that section 104(a)(1) of the 
Code excludes from gross income amounts received by an employee under a 
workers' compensation act or under a statute in the nature of a 
workers' compensation act that provides compensation to the employee 
for personal injury or sickness incurred in the course of employment.
    The IRS takes the position that gross income for income tax 
purposes is a separate concept from wages for purposes of FICA. 
Furthermore, exclusions from wages for FICA purposes are to be 
construed narrowly. Thus, amounts that are excluded from gross income, 
in the absence of a specific statutory or regulatory exclusion from 
wages, constitute wages for FICA.
    Pursuant to the income tax regulations, payments made under a 
statute in the nature of a workers' compensation act are excluded from 
gross income under section 104. However, there is no regulation at 
present addressing whether such payments are excluded from wages for 
FICA purposes.
    Through 1989, the IRS issued several private letter rulings 
concluding that payments made under a statute in the nature of a 
workers' compensation act were excluded from gross income and exempt 
from FICA. In 1990, based on the Service's position that the exclusion 
from gross income did not necessarily

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result in an exclusion from wages, and the absence of a regulation on 
point, the IRS reversed its ruling position with respect to FICA, 
holding that payments made under a statute in the nature of a workers' 
compensation act are included in wages, until the employee has been 
absent from work in excess of six months; once the employee has been 
absent from work for more than six months, the payments are excluded 
from FICA by section 3121(a)(4).
    Questions have arisen concerning the FICA tax treatment of payments 
made under a statute in the nature of a workers' compensation act to 
employees of States and local governments who are not eligible to 
receive payments under a workers' compensation law. Accordingly, the 
IRS and Treasury are seeking to provide rules to clarify the treatment 
of such payments during the first six months the employee is out of 
work.
    Under the proposed regulations, payments made under a statute in 
the nature of a workers' compensation act will be treated as having 
been made under a workers' compensation law and, therefore, will be 
excluded from wages for FICA purposes. Thus, the regulations adopt the 
same position that was published in Rev. Proc. 82-20, the most 
contemporaneous guidance to the legislation that created the current 
statutory scheme. The proposed regulations thus align the 
interpretation of what constitutes payments received under a workers' 
compensation law for purposes of section 3121(a)(2)(A) with the 
interpretation of amounts received under a workers' compensation law 
for purposes of section 104(a)(1).
    These proposed regulations are intended to address only the 
treatment of payments under a statute in the nature of a workers' 
compensation act for FICA purposes. The existing temporary regulations 
under section 31.1 which address the FICA treatment of payments under a 
workers' compensation law also provide guidance to third parties making 
payments on account of sickness or accident disability. Treasury and 
the IRS are not proposing any changes to the regulations with respect 
to the FICA treatment of third-party sick pay. To the extent it is 
necessary to modify the temporary regulations to harmonize them with 
these proposed regulations, the third-party sick pay provisions will be 
preserved. To the extent necessary, future guidance will also address 
the treatment of payments on account of sickness or accident disability 
for Federal Unemployment Tax Act and Railroad Retirement Tax Act 
purposes.

Proposed Effective Date

    It is proposed that these regulations apply to payments made on or 
after the date the proposed regulation is published as Final in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
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) does not apply to these regulations. In addition, 
because no collection of information is imposed on small entities, the 
provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply, and, therefore, a Regulatory Flexibility Analysis is not 
required. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on the impact on small 
business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written or electronic comments that 
are submitted timely to the IRS. The IRS and Treasury Department 
request comments on all aspects of the proposed regulations and how 
they can be made easier to understand. All comments will be available 
for public inspection and copying. A public hearing may be scheduled if 
requested in writing by any person that timely submits written 
comments. If a public hearing is scheduled, notice of the date, time, 
and place for the public hearing will be published in the Federal 
Register.

Drafting Information

    The principal author of these regulations is David Ford of the 
Office of Division Counsel/Associate Chief Counsel (Tax Exempt/
Government Entities). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 31

    Employment taxes and collection of income at the source.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 31 is proposed to be amended as follows:

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

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

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

    Par. 2. Section 31.3121(a)(2)-1 is amended by:
    1. Revising the section heading.
    2. Removing paragraph (a)(1).
    3. Redesignating paragraphs (a)(2) through (a)(4) as (a)(1) through 
(a)(3), respectively.
    4. Revising newly designated paragraph (a)(1).
    5. Redesignating paragraph (d) as paragraph (f).
    6. Adding new paragraphs (d) and (e).
    The revisions and additions are as follows:


Sec.  31.3121(a)(2)-1  Payments on account of sickness or accident 
disability, medical or hospitalization expenses, or death.

    (a) * * *
    (1) Sickness or accident disability of an employee or any of his 
dependents, only if payment is received under a workers' compensation 
law;
* * * * *
    (d) Workers' compensation law. (1) For purposes of paragraph (a)(1) 
of this section, a payment made under a workers' compensation law 
includes a payment made pursuant to a statute in the nature of a 
workers' compensation act.
    (2) For purposes of paragraph (a)(1) of this section, a payment 
made under a workers' compensation law does not include a payment made 
pursuant to a State temporary disability insurance law.
    (3) If an employee receives a payment on account of sickness or 
accident disability that is not made under a workers' compensation law 
or a statute in the nature of a workers' compensation act, the payment 
is not excluded from wages as defined by section 3121(a)(2)(A) even if 
the payment must be repaid if the employee receives a workers' 
compensation award or an award under a statute in the nature of a 
workers' compensation act with respect to the same period of absence 
from work.
    (4) If an employee receives a payment on account of non-
occupational injury sickness or accident disability such payment is not 
excluded from wages, as defined by section 3121(a)(2)(A).
    (e) Examples. The following examples illustrate the principles of 
paragraph (d) of this section:

    Example 1. A local government employee is injured while 
performing work-related

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activities. The employee is not covered by the State workers' 
compensation law, but is covered by a local government ordinance 
that requires the local government to pay the employee's full salary 
when the employee is out of work as a result of an injury incurred 
while performing services for the local government. The ordinance 
does not limit or otherwise affect the local government's liability 
to the employee for the work-related injury. The local ordinance is 
not a workers' compensation law, but it is in the nature of a 
workers' compensation act. Therefore, the salary the employee 
receives while out of work as a result of the work-related injury is 
excluded from wages under section 3121(a)(2)(A).
    Example 2. The facts are the same as in Example 1 except that 
the local ordinance requires the employer to continue to pay the 
employee's full salary while the employee is unable to work due to 
an injury whether or not the injury is work-related. Thus, the local 
ordinance does not limit benefits to instances of work-related 
disability. A benefit paid under an ordinance that does not limit 
benefits to instances of work-related injuries is not a statute in 
the nature of a workers' compensation act. Therefore, the salary the 
injured employee receives from the employer while out of work is 
wages subject to FICA even though the employee's injury is work-
related.
    Example 3. The facts are the same as in Example 1 except that 
the local ordinance includes a rebuttable presumption that certain 
injuries, including any heart attack incurred by a firefighter or 
other law enforcement personnel is work-related. The presumption in 
the ordinance does not eliminate the requirement that the injury be 
work-related in order to entitle the injured worker to full salary. 
Therefore, the ordinance is a statute in the nature of a workers' 
compensation act, and the salary the injured employee receives 
pursuant to the ordinance is excluded from wages under section 
3121(a)(2)(A).
* * * * *

Mark E. Matthews,
Deputy Commissioner of Services and Enforcement.
[FR Doc. 05-4382 Filed 3-10-05; 8:45 am]
BILLING CODE 4830-01-P