The Internal Revenue Code requires employers to either pay or collect a series of taxes related to compensation paid to employees. A recent ruling by the Sixth Circuit addressed the question of whether payments made to separated employees pursuant to supplemental employment compensation plans (SUB payments) constitute "wages" subject to FICA. United States v. Quality Stores, Inc., No. 10-1563 (6th Cir. Sept. 7, 2012). At issue was whether the Section 3402(o) exclusion of SUB payments for withholding purposes created a parallel exclusion of SUB payments from the definition of "wages" for FICA purposes.
The Sixth Circuit ruled that the Section 3402(o) exclusion of SUB payments from the definition of wages for withholding purposes also applies to the definition of wages for FICA purposes. The court rejected the government's argument that the statutory definitions of "wages" differ under the two provisions, noting statutory amendments and legislative history that the government contended had "de-coupled" the definition of wages for the two provisions.
Interestingly, the Federal Circuit had reached the opposite result in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), concluding that SUB payments should be treated as "wages" for FICA purposes. The CSX and Quality Stores decisions address essentially the same arguments and both courts acknowledged that the statutory construction issue is close. Nonetheless, the result is a direct circuit conflict, and the issue may be taken up by other circuits or the Supreme Court before it is put to rest
For present purposes, the most important question is identification of the types of payments that might fall within the reasoning of Quality Stores. The statutory definition of SUB payments provides:
For purposes of [chapter 24 of the Internal Revenue Code, which deals with income tax withholding], the term "supplemental unemployment compensation benefits" means amounts which are paid to an employee, pursuant to a plan to which the employer is a party, because of an employee's involuntary separation from employment (whether or not such separation is temporary), resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions, but only to the extent such benefits are includible in the employee's gross income.
The Sixth Circuit construed this definition as having five separate elements:
- An amount is paid to an employee;
- The amount is paid pursuant to an employer's plan (the case law appears to provide some flexibility regarding how formal this plan needs to be);
- The amount is paid because of an employee's involuntary separation from employment, whether temporary or permanent;
- The separation results directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and
- The amount is included in the employee's gross income.
The ultimate outcome of the litigation involving the taxation of SUB payments for FICA purposes is still unknown. According to the government, the Internal Revenue Service (IRS) already has recieved more than $1 billion in claims asserting the Quality Stores legal theory. The government filed a petition for rehearing en banc in the Sixth Circuit earlier this week, suggesting that the IRS is not ready to give up the fight just yet. Even if that petition is denied, it still can seek certiorari in the Supreme Court. Alternatively, the IRS may announce a formal change in position accepting some or all of the Sixth Circuit's analysis. Either way, it is unlikely that the government will allow disparate treatment of taxpayers in different circuits to continue for long.
In the interim, clients should protect themselves from statute of limitations issues by filing refund claims for all open years asserting that the Quality Stores reasoning applies to the broadest possible categories of SUB payments. Presumably, the IRS will adopt a "go slow" approach in reviewing these claims and should hold them in abeyance pending final resolution of the Quality Stores litigation. Even if the IRS audits and formally rejects the claims, taxpayers still will have two years to file suit, by which time the uncertainty in the law should be resolved.