Clark v. Modern Group Ltd.

• Decision Date: 22 December 1993
• Docket Number: No. 92-2048,92-2048
• Parties: , 126 Lab.Cas. P 57,557, 8 Indiv.Empl.Rts.Cas. (BNA) 1803 William N. CLARK, Appellant, v. MODERN GROUP LTD.; John F. Smith.
• Court: U.S. Court of Appeals — Third Circuit

Page 321

9 F.3d 321

62 USLW 2364, 126 Lab.Cas. P 57,557,

8 Indiv.Empl.Rts.Cas. (BNA) 1803

William N. CLARK, Appellant, v. MODERN GROUP LTD.; John F. Smith.

No. 92-2048.

United States Court of Appeals, Third Circuit.

Argued June 21, 1993.

Decided Nov. 18, 1993.

Sur Petition for Rehearing Dec. 22, 1993.

Stephen G. Console (argued), Mark S. Scheffer, Law Offices of Stephen G. Console, Philadelphia, PA, for appellant.

Nicholas N. Price (argued), Schnader, Harrison, Segal & Lewis, Philadelphia, PA, for appellee Modern Group Ltd.

Before STAPLETON, MANSMANN and HUTCHINSON, Circuit Judges.

OPINION OF THE COURT

HUTCHINSON, Circuit Judge.

Appellant William N. Clark ("Clark") appeals an order of the United States District Court for the Eastern District of Pennsylvania granting appellee Modern Group Ltd.'s ("Modern") motion for summary judgment on Clark's claim for wrongful discharge. Clark argues that Modern terminated his at-will employment in violation of public policy. Specifically, he contends his termination resulted from his objections to Modern's refusal to report as taxable income certain auto expense reimbursements to its executives on their 1990 W-2 withholding statements. For purposes of summary judgment, we must assume that Clark's objections to Modern's refusal to report the auto expense it paid its executives was the cause of his discharge. Pennsylvania law will determine whether Clark's discharge was wrongful, but federal law determines whether Modern and its executives violated the Internal Revenue Code.

In Pennsylvania, an employer may terminate an at-will employee with or without justification unless the reason for the discharge offends a clear mandate of public policy. Clark asks us to hold that Pennsylvania's public policy exception to the at-will doctrine extends to cases in which an employee "reasonably believes" that his employer has requested him to perform an unlawful act and is discharged for objecting to the proposal he believes is unlawful. ¹ We predict that the Pennsylvania Supreme Court would not recognize the extension Clark seeks. Therefore, Clark bears the burden of demonstrating Modern's refusal to report its executives' reimbursed auto expenses on their 1990 W-2 forms was indeed illegal under federal tax law. After analyzing that tax law, we hold that Clark's belief that the auto expense reimbursements he questioned were reportable as income in 1990 by Modern's executives and therefore subject to withholding by Modern, though reasonable, was wrong. Accordingly, we will affirm the district court's order granting Modern's motion for summary judgment on Clark's claim.

I.

From September 26, 1986, until his termination on February 28, 1991, Clark served as Vice-President of Finance and Chief Financial Officer of Modern. He was a knowledgeable financial officer and a Certified Public Accountant.

In 1986, Modern employed Runzheimer International ("Runzheimer") to fashion a plan for reimbursement of company employees who used their own automobiles for company business which would provide it and its employees with optimal tax benefits. Runzheimer installed a Fixed and Variable Rate Allowance ("FAVR") plan. Under it, twenty-nine percent of an employee's auto expense reimbursement was treated as taxable income, but the remaining seventy-one percent was excluded from income as employee business related expense.

In 1988, Congress amended I.R.C. Sec. 62's provisions on the tax treatment of employees' reimbursed business expenses. See 26 U.S.C.A. Sec. 62(a)(2)(A), (c) (West Supp.1993). Thereafter, in 1989, the Treasury Department and the Internal Revenue Service ("IRS") began considering regulations to implement the Code's changes in the income tax treatment of reimbursed expenses. Among the issues considered was the means by which an employee could "substantiate" the fact that an expense was incurred in the "ordinary and necessary" pursuit of the employer's business.

In general, under the Internal Revenue Code and the regulations, employee reimbursements or allowances for ordinary and necessary business expenses the employee incurs in the pursuit of his or her employer's business are not reportable, subject to withholding or included in the employee's income so long as the employee is required to account to his employer for them. The accounting must be adequate and an accounting is not adequate without substantiation. See 26 U.S.C.A. Sec. 274(d) (West Supp.1993); 26 U.S.C.A. Sec. 6001 (1989); see also James W. Pratt et al., Individual Taxation 415 (1988).

Reimbursements that exceed the amount substantiated must be included in the employee's gross income. See Temp.Treas.Reg. Sec. 1-62-2T(e), 54 Fed.Reg. 51021 (1989). IRS initially considered the effect of the 1988 changes in Revenue Procedure 89-66, 1989-2 C.B. 792. Later, in 1990, IRS published Revenue Procedure 90-34. It addressed reimbursements for auto expenses that an employer paid to its "control group" employees inadequately accounted for under plans similar to Modern's FAVR plan. Thus, Revenue Procedure 90-34 brought into serious question the legality of excluding certain executives' auto expense reimbursements from the executives' income and the Code's withholding requirements under a FAVR-type plan. See Rev.Proc. 90-34, 1990-1 C.B. 553.

Modern became aware of the effect these changes and proposed changes could have in the tax treatment of its payments to its employees for their auto expenses some time in the summer of 1990. Kraig Rodenbeck, a Runzheimer employee, told Modern that he considered IRS Revenue Procedure 90-34 to be effective as of June 1990. If this were right, the auto expenses Modern had been paying its control group employees would be taxable income unless they could be substantiated, as that term was defined by the temporary tax regulations the Treasury Department had proposed, but not finally approved. ² Rodenbeck also informed Modern, however, that IRS would be satisfied if it showed it had tried in good faith to comply in 1990 but could not do so until 1991.

In the meantime, Runzheimer had also had a separate opinion letter prepared for its own use by Peat Marwick, its tax advisor. ³ In its opinion, Peat Marwick had concluded that the regulatory changes resulting from issuance of Revenue Procedures 89-66 and 90-34 made employer auto expense reimbursements "to employees that qualify as covered After reviewing Peat Marwick's report, Runzheimer sent a letter to Modern, dated November 9, 1990, urging it to "seek counsel from your tax advisors relative to compliance with Revenue Procedure 90-34...." Appellant's Appendix ("App.") at 58. Runzheimer's November 9, 1990 letter also advised Modern that it should have begun withholding taxes on auto expense reimbursements to control group employees on July 1, 1990.

employees" (therefore excluding "control group" employees) under a FAVR plan subject to withholding if reimbursement was in excess of any amounts substantiated. With respect to reimbursements that are not substantiated, Peat Marwick was of the opinion that any amounts paid to employees who did not elect the standard mileage allowance of twenty-six cents per mile would have to be included in the employee's income and reported on the employee's W-2 form. Peat Marwick did not give an opinion on the effective date of the requirement that excess reimbursement to control group employees had to be included in their W-2 forms.

In September or October of 1990 Clark had himself become aware of Modern's potential liability for withholding under its FAVR plan. Then, after reviewing the text of the statutory changes, the regulations IRS proposed in order to implement them and other material explaining their effect, Clark concluded that Revenue Procedures 89-66 and 90-34 had indeed required Modern to begin withholding federal income taxes and paying federal employment taxes on the auto expenses it was reimbursing to its control group employees. At a meeting near the end of 1990, Clark advised Modern's management that Modern would have to report auto expense reimbursements as income to its control group employees on the 1990 W-2 forms that the tax Code required it to distribute by January 31, 1991.

Clark instructed Bruce Pflaumer ("Pflaumer"), Modern's Assistant Controller, to prepare a summary of the potential additional income the control group employees would have under the new IRS regulations. Clark also directed John Lauf ("Lauf"), Modern's Controller, to get ready to issue supplemental W-2 forms to control group employees showing the additional income Pflaumer's summary was expected to show for them. Lauf contacted Carl Wilkinson ("Wilkinson"), one of the affected employees, about how to break the bad news to the control group employees. Wilkinson told Lauf that the problem would be brought up at a management meeting on January 25, 1991. On December 17, 1990, however, unbeknownst to Clark or the others at Modern, Treasury issued a final regulation on employee expenses, Treasury Regulation Sec. 1.62-2. It stated that the new procedures concerning inclusion of auto expenses in an employee's income and the consequent requirement that tax on them be withheld would not become effective until January 1, 1991. Treas.Reg. Sec. 1.62-2(m) (1990).

Clark and Modern's managers apparently remained in ignorance of the final regulation on January 25, 1991, the date of the meeting at which the problem was to be discussed. At the meeting, Clark presented Pflaumer's summary. It showed nine of Modern's officers would have to report an aggregate $28,053.00 additional income for 1990 because of the auto expenses Modern had reimbursed them. These officers objected to Modern's issuing W-2 forms to them that would add reimbursed auto expenses to their 1990 income. One officer is supposed to have said, when he had spoken with Runzheimer about the issue, that he was told not to worry about 1990 because the IRS was so backed up that...