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The Philadelphia Phillies are not entitled to a refund of the federal wage taxes it paid under protest in 1994 after paying its share of a $280 million settlement with players who contended that teams had interfered with their free-agency rights, a federal judge has ruled. The settlement payment was the legal equivalent of “wages,” since baseball officials themselves considered it reimbursement for lost compensation, federal Judge William H. Yohn Jr. of the U.S. District Court for the Eastern District of Pennsylvania found in his 13-page opinion in The Phillies v. United States. Yohn’s ruling is one of the first in the country to address the issue. Nearly every baseball team involved has filed a similar suit in its home district. So far, the teams are on a losing streak. Judges in San Francisco and St. Louis also have ruled that the settlement money should be treated as wages. In addition, the U.S. Supreme Court dealt the teams a defeat last month when it rejected their argument that back wages should be taxed for the year in which the pay would have been earned. Instead, the justices upheld the longstanding IRS rule that back wages are taxed for the year they are actually paid. The genesis of the lawsuits is in a series of grievances filed in the 1980s by the Major League Baseball Players’ Association against 26 Major League baseball clubs. The grievances allege that the clubs had violated the collective bargaining agreement by colluding to inhibit free agency. The free-agency system prohibited concerted action among players or among the clubs and required that disputes be submitted to a panel for binding arbitration. The first grievance was filed in 1986 and alleged collusion in the 1985-86 baseball season. A second and third alleged collusion in the 1986-87 and 1987-88 seasons. Arbitration panels found that the clubs had interfered with the contractual rights of the players by acting in concert to preclude or to hinder players who were free agents from leaving their clubs after the 1985 and 1986 baseball seasons, and by acting in concert to depress overall salary levels and the levels of other contract benefits and special covenants after the 1987 season by sharing information as to what offers were being made to free-agent players. The panels found that free agents had lost more than $113 million in salary over three years. The case later was settled for much more. In 1990, the clubs agreed to pay the union $280 million, a figure that included more than $36 million in pre-settlement interest. Each of the 26 clubs contributed 1/26th of the total settlement, which covered not only the three years considered by the arbitrators, but all possible claims that players’ salaries were depressed in subsequent years. It was left to the union to decide how to distribute the money to the players. In 1994, the union paid 12 former Phillies more than $1.8 million in damages and more than $500,000 in interest. The Phillies reported $63,941 as their share of FICA taxes on the distribution and paid the IRS that amount along with $504 in federal unemployment taxes. Under the settlement, the clubs were required to seek an IRS private letter ruling on the payroll tax treatment of the settlement distributions to the players. The clubs did not admit that the settlement payments were wages but said that if the payments were ruled to be wages, they would assume the tax liability for any player awarded damages for a year in which he was on their team. Ultimately, the IRS ruled that all but the interest portion of the settlement payments should be treated as wages. The Phillies filed for a refund of more than $64,000. When it was denied, the club filed suit. Now Yohn has ruled that the IRS ruling was completely correct and that the Phillies are entitled to a refund of just $9,108 for the taxes they paid on the interest portion of the distribution to Phillies players. Yohn agreed with government lawyers who argued that the distributions to Phillies players were intended to compensate free agents for shortfalls in their salaries and, therefore, should be considered wages. But the Phillies insisted that the payments were actually damages for breach of the contract. And since the payments were made by all 26 clubs, they didn’t really arise from an employer-employee relationship. Yohn disagreed, saying that the arbitration panels had based their awards on calculations of the players’ lost salaries. The clubs also recognized that the awards were salary-based, Yohn found, since they opposed any demands for nonsalary-related remedies. Yohn also rejected the Phillies’ argument that one cannot pay “wages” to a nonemployee and that the Phillies players who received distributions from the settlement were not employees of the 25 clubs that paid 25/26ths of the distributions. “This clever argument ignores the fact that the classification of the distributions as wages or as nonwages depends on the nature of the underlying claim, not just the structure of the payment scheme,” Yohn wrote. “Because the underlying claim clearly shows that the distributions are basically back wages, the structure of the payment scheme is immaterial.” The Phillies also pointed out that the settlement was with the union, not the individual players, and that the union distributed the proceeds to the players. But Yohn said that technicality meant nothing since “the dominant reason for making the settlement payments was to cover the players’ salary shortfalls.” The Phillies were represented by attorneys Charles B. Blakinger of Hoyle Morris & Kerr in Philadelphia, and James L. Huston and Zhu Lee of Foley & Lardner in Milwaukee. The government was represented by Christopher R. Zaetta in the Justice Department’s tax division.

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