Based on recent federal court rulings, employers in Ohio, Kentucky, Michigan, and Tennessee may wish to file protective refund claims if they paid federal FICA employment taxes on certain severance payments to employees in 2009 or later. The deadline for 2009 claims is April 15, 2013.
On January 4th, the United States Court of Appeals for the Sixth Circuit denied the government's petition for en banc rehearing in United States v. Quality Stores, Inc., Case No. 10-1563. This latest ruling leaves in place for now the Court's September 2012 decision that held the payments at issue were not "wages" within the meaning of the Federal Insurance Contributions Act (FICA) and so were not subject to FICA taxes. Because the Sixth Circuit's decision on the issue conflicts with an earlier decision by the Federal Circuit in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), the Supreme Court may render the final decision on the issue if the government appeals the Quality Stores decision. The IRS has reported that the fate of more than a billion dollars worth of tax refund claims likely will depend on the ultimate outcome.
Certain Severance Payments Are SUB Payments Under I.R.C. § 3402(o)
At issue in Quality Stores were severance payments that an employer made to many of its employees because of the employees' involuntary separation from employment connected to workforce reductions and the discontinuance of the employer's operations. The employer made the payments pursuant to written plans and based the amount of the payments on each employee's job grade, length of service, and management level, among other factors. Some employees received payments over time according to the employer's normal payroll schedule, while others received the payments in a lump sum. Employees were not required to provide any particular services to receive the payments. One of the plans, designed to provide an incentive for employees to defer their job searches, required employees to work through their last scheduled day of service to receive the payment. Payments under both plans ranged in amount from one week's pay to twelve months' pay, and employees at nearly all levels from hourly employees to senior management received the payments.
In its September 2012 decision, the Sixth Circuit concluded that these payments were supplemental unemployment compensation benefits ("SUB payments") within the meaning of Internal Revenue Code (I.R.C.) § 3402(o) because the payments satisfied the five-part test contained in the statute. Under the statutory test as interpreted by the Sixth Circuit panel, severance constitutes a SUB payment if it is "(1) an amount paid to an employee; (2) pursuant to an employer's plan; (3) because of an employee's involuntary separation from employment, whether temporary or permanent; (4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee's gross income."
SUB Payments Are Not "Wages" and So Are Not Subject to FICA Taxes
The Court determined that SUB payments are not subject to FICA taxes because such payments do not constitute "wages" within the meaning of the FICA statute, even though they are subject to federal income tax withholding under I.R.C. § 3402(o)
I.R.C. § 3402(o) defines SUB payments and characterizes them as "other than wages," but nonetheless provides that a SUB payment "shall be treated as if it were a payment of wages" for purposes of federal income tax withholding. The Sixth Circuit panel inferred from this language that Congress did not consider SUB payments to be wages.
The definitions of "wages" in the federal income tax withholding statute and in the FICA tax withholding statute are nearly identical. In Rowan Cos. v. United States, 452 U.S. 247 (1981), the U.S. Supreme Court found "that Congress intended the term 'wages' to carry the same meaning for purposes of FICA and federal income tax withholding." In Quality Stores, the Sixth Circuit panel rejected the IRS's argument that Congress had superseded Rowan by enacting a "decoupling amendment" to the Social Security statute in 1983. Although the legislative history of the amendment showed clearly that Congress believed that "an employee's 'wages' for Social Security tax purposes may be different from the employee's 'wages' for income tax withholding purposes," the Court found that the language of the statute as enacted failed to implement Congress's intention. Therefore, the Court concluded that Rowan remains good law, and so because SUB payments are not wages for income tax withholding purposes, they also are not wages for FICA tax purposes. In other words, the statutory mandate to withhold for income tax purposes does not extend to require withholding for FICA tax purposes.
Options for Employers
Employers that have paid FICA taxes on severance payments qualifying as SUB payments may wish to consider filing protective refund claims with the IRS. Such a refund claim generally must be filed within three years of when the tax return at issue was due, so April 15, 2013, will be the deadline for refund claims related to 2009 severance payments. I.R.C. §§6511(a) and 6513(c).
Sources we have reviewed indicate that the IRS has been denying such FICA refund claims from taxpayers located outside the jurisdiction of the Sixth Circuit, and has been holding and not acting on such claims from Sixth Circuit taxpayers – those located in Ohio, Kentucky, Michigan, and Tennessee. If the IRS denies a taxpayer's claim, the taxpayer generally has two years from the notice of disallowance to initiate a lawsuit challenging the denial. As an alternative to an immediate lawsuit, the taxpayer may petition the IRS to voluntarily extend the two-year period by filing Form 907, Agreement to Extend the Time to Bring Suit. There is some indication that the IRS has been approving such requests with respect to refund disallowances that would be affected by the ultimate outcome of the Quality Stores litigation.