Employers Should Consider Filing Refund Claims

In a recent decision, the Sixth Circuit Court of Appeals held that severance payments to former employees that are supplemental unemployment compensation benefits (SUBs) are not “wages” for FICA tax purposes. United States v. Quality Stores, Inc., No. 10-1563, 2012 U.S. App. LEXIS 18820 (6th Cir. Sept. 7, 2012). This decision is at odds with the Federal Circuit decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008). (For our prior analysis of the district court decision in Quality Stores and the Federal Circuit decision in CSX Corp., click here).

The IRS has now petitioned the Sixth Circuit for rehearing en banc. If it not successful in the court of appeals, the IRS will surely seek Supreme Court review. Although a definitive ruling on this issue is probably years away, employers need to determine what potential FICA refund claims they have and what to do to protect those claims.

The Quality Stores Decision

Quality Stores was once the largest agricultural retailer in the country. In 2001, the company filed for Chapter 11 bankruptcy. By 2002, all employees had been terminated. During this time, Quality Stores made lump-sum and periodic severance payments to its former employees. Quality Stores withheld FICA taxes on these amounts and remitted the taxes to the IRS. Quality Stores then filed refund claims for more than $1 million, arguing that the severance payments were SUBs and not wages for FICA tax purposes.

The Sixth Circuit affirmed the district court’s holding that the severance payments were SUBs and not FICA wages. In its analysis, the court of appeals noted that the Supreme Court had determined in Rowan Cos. v. United States, 452 U.S. 247 (1981), that Congress intended for the term “wages” to carry the same meaning for income-tax withholding purposes as for FICA tax purposes. Thus, the court reasoned that because Congress provided in Section 3402(o) of the Internal Revenue Code (Code) that SUBs are not included as wages for income tax withholding purposes, they are also not included as wages for FICA tax purposes under Code Section 3121(a) as well.

What Payments Count as SUBs Under Quality Stores?

Based upon Section 3402(o), the Sixth Circuit defined a SUB as:

  • An amount paid to an employee;
  • Pursuant to an employer’s plan;
  • Because of an employee’s involuntary separation from employment, whether temporary or permanent;
  • Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and
  • That is included in the employee’s gross income.

This definition does not include other types of postemployment severance payments. For example, assume that an employer terminates an employee for poor performance, and not as a result of a reduction in force or the discontinuance of a plant or operation, and pays this person a severance benefit in consideration for his or her release of all employment-related claims. Such a benefit would not be a SUB and would be subject to FICA.

What Amount of FICA Tax Can an Employer Recover?

An employer may seek a refund of both the employee and employer portions of FICA tax on SUB payments. Before filing a refund claim, the employer must either (i) reimburse the former employee for his or her portion of the FICA tax or (ii) obtain his or her written consent to pursue a refund claim. However, failure to comply with this requirement will not prevent the employer from filing a refund claim as long as it makes a reasonable effort to reimburse the former employee or secure his or her consent.

An employer who files a claim for refund or credit of employee FICA tax collected on SUB payments from an employee in a calendar year before the year in which the credit or refund is claimed must also certify as part of the claim process that it has obtained the employee’s written statement that he or she has not claimed a refund or credit of the amount of the overcollection, or if so, that such claim has been rejected and that he or she will not claim a refund or credit of the amount.

Employers will be required to provide documentation of any reimbursements, consents or statements from such persons.

How Far Back Can an Employer Go in Seeking FICA Refunds?

To request a refund, employers must file an IRS Form 941-X. This form must be filed within three years of the date a Form 941 is filed or, if later, within two years of the date any FICA taxes are paid. A Form 941 is deemed filed on April 15 of the year following the quarter in which it is filed.

For example, to claim a refund for FICA taxes paid with a Form 941 that was filed in the first quarter of 2009, an employer must file a Form 941-X by April 15, 2013.

If a Form 941-X is Filed, What Else Must the Employer Do?

The IRS will review the employer’s refund claim and either grant or deny it. If the IRS denies the claim, the employer has two years from the date of denial to file a lawsuit to preserve its ability to seek a refund. This was the course taken in both Quality Stores and CSX.

An employer filing a Form 941-X on or after December 2012 could wait for the Sixth Circuit and possible Supreme Court litigation to conclude before deciding whether to file suit.

What Should Employers Do Now?

Employers with large reductions in force in 2009 or later may have made severance payments that qualify as SUBs under Quality Stores. Such employers, whether or not having operations in the Sixth Circuit (Kentucky, Michigan, Ohio and Tennessee), should review their records to determine whether any significant payments of SUBs were made and subjected to FICA tax. Employers in these circumstances would be wise to consider filing refund claims to preserve their right to recover FICA payments if Quality Stores is upheld after all appeals are exhausted.