Another chapter has been written in the long-running saga of whether Federal Insurance Contributions Act (FICA) tax refunds are available for reduction-in-force (RIF) severance pay.  

In 2002, the Court of Federal Claims held that some types of severance pay were exempt from Social Security taxation under the FICA. The exemption applied if the requirements in section 3402(o) of the Internal Revenue Code were met: (1) an amount was 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) was included in the employee's gross income. CSX Corporation v. United States, 52 Fed. Cl. 208 (2002).

The position of the IRS, as set forth in its revenue rulings going back to the 1950s, is that the FICA exclusion exists only if the payments were designed to supplement state unemployment benefits — generally meaning that the payments were made in installments and were conditioned on the individual's ongoing eligibility for state unemployment benefits.

Many employers filed protective refund claims following the trial court's decision in CSX, but that decision was reversed by the Federal Circuit in 2008. CSX Corporation v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

In 2010, a Michigan court rejected the Federal Circuit's analysis and agreed with the taxpayer that severance plan payments made in connection with an involuntary reduction in force were not "wages" under FICA. United States v. Quality Stores, Inc., 2010 U.S. Dist. LEXIS 15825 (W.D. Mich. Feb. 23, 2010). Last week, the Sixth Circuit affirmed that decision. United States v. Quality Stores, Inc., 2012 U.S. App. LEXIS 18820 (6th Cir.) (6th Cir. Sept. 7, 2012). The government may, of course, decide to appeal the case to the United States Supreme Court.

The Sixth Circuit's decision is binding only within that circuit (i.e., Kentucky, Ohio, Michigan and Tennessee). Employers in the Sixth Circuit who have made involuntary termination severance payments pursuant to a plan definitely should file refund claims in reliance on Quality Stores, even though it may be appealed.

Employers elsewhere should strongly consider filing refund claims as well. If the government appeals and the Supreme Court affirms the Sixth Circuit, the ruling would have nationwide effect and the government would be obligated to pay refunds. If the government does not appeal, or if the Supreme Court does not take the case, then there will be continuing uncertainty in states outside the Sixth Circuit. The IRS likely will adhere to its ruling position in that event, but there may be enough tax dollars at stake to make it worthwhile for some employers to litigate, especially given the taxpayer's success in Quality Stores.