On September 7, 2012, a unanimous panel of the U.S. Court of Appeals for the Sixth Circuit affirmed the decision of a federal district court in Western District of Michigan, and its bankruptcy court, that had both held that severance payments made by an employer plan to involuntarily terminated employees resulting from a reduction in force or discontinuance of a plant or operation were not subject to FICA tax. In re Quality Stores, No. 10-1563. This long-awaited decision, designated for publication, brings the Sixth Circuit into a “split” with the decision of the U.S. Court of Appeals for the Federal Circuit in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

The recent case addressed a situation in which the parties had stipulated that: (1) the employer made the payments to employees; (2) pursuant to company plans; (3) because of the employees’ permanent separation from employment; and (4) resulting directly from a reduction in force or the discontinuance of a plant or operation. Around the nation, many large employers have, in connection with an economic downturn, made payments of this nature to large numbers of employees. (These payments are sometimes referred to as supplemental unemployment benefit payments — “SUB payments,” for short.) In connection with these payments, most employers and former employees have paid FICA tax to the IRS.

Large employers have long been aware of the fact that whether FICA tax is due on these types of payments is in dispute. A decade ago, in the wake of the economic downturn that occurred after 9/11, many corporate employers engaged in largescale layoffs. Many of these employers filed “protective claims” for refund for that FICA tax, with the claims for refund encompassing both the employer’s and the employees’ shares. These claims often sought many millions, or even many tens of millions, of dollars in tax refunds. While the CSX Corp. case made its way through the courts, it was IRS’s practice to take no action on these types of claims — to put them in suspense. But after the IRS won the CSX Corp. case in 2008, the IRS began to formally notify many taxpayers that their claims for refund were disallowed. Any that any suit to challenge that disallowance must be brought within a two-year period following the notice of disallowance.

Of course, additional large-scale layoffs occurred after the economic crash of 2008. Many employers made severance payments in connection with these layoffs. But the IRS’s victory in CSX Corp. in March 2008 caused some employers to refrain from even filing protective claims with the IRS — they assumed that the battle was over.

In the wake of the taxpayer’s recent win in the Sixth Circuit, the government may ask that court to rehear the case or to rehear it en banc, emphasizing that the court has brought itself into “split” with the Federal Circuit’s CSX Corp. case. Unless the Sixth Circuit reverses itself, the government is likely to ask the U.S. Supreme Court to hear the case, emphasizing the need for nationwide uniformity and the large amount of revenue that is at stake nationwide. To further complicate the picture, it is not inconceivable that Congress might address the situation with legislation or that the Treasury Department might intervene with a regulation.

Next Steps. Currently, most employers who previously paid FICA tax on severance or SUB payments respecting layoffs sit in one or more of several different procedural postures:  

  • Refund Claim Filed and Disallowed by IRS.
  • Refund Claim Filed but No Action Taken by IRS.
  • Refund Claim Not Filed.

Obviously, the Sixth Circuit’s decision in In re Quality Stores suggests that employers with significant tax at stake who have not yet filed refund claims should consider doing so as soon as possible. Employers should consider whether the claim should be presented as a “protective claim” or as a standard, non-protective claim — and consider the extent to which they may defer obtaining the required “consents” from former employees who by law are permitted to “piggyback” on the employer’s claim and suit. Employers with a claim that is pending or that has been disallowed should consider whether and when to commence suit. (All suits would have to go to a U.S. district court, in view of the fact that a refund of employment taxes is involved, and that the CSX Corp. decision forecloses the Court of Federal Claims as a venue.) Employers should keep in mind the possible application of the six-year, “outside limit” statute of limitation, found in 28 USC, Section 2401, which has been receiving increasing attention from courts and commentators. It may be advantageous, depending upon the circuit in which the employer has its principal place of business, to commence suit before it is known whether the Supreme Court will hear the case, whether Congress will legislate, or whether the Treasury Department will promulgate a new regulation. Of course, employers pursuing a refund should take appropriate measures to comply with all document-preservation duties.


Five courts have now looked at the severance-pay issue. Four have ruled in favor of the taxpayer (bankruptcy and district courts in Michigan; the Sixth Circuit; and the Court of Federal Claims, in the CSX Corp. case). Only one (the Federal Circuit, in the CSX Corp. case) has ruled in favor of the IRS.

The latest win suggests that employers should re-focus on this issue, especially because the amount of FICA tax involved frequently runs into “real money” — millions or even tens of millions of dollars. Plotting out appropriate next steps for an employer involves taking the employer’s particular circumstances into account as well as trying to predict what the Supreme Court, other courts, Congress, and the Departments of Treasury and Justice will do. Complicated procedural rules found in the Internal Revenue Code and in the Judicial Code apply to any effort to plot strategy, assess hazards, assess settlement prospects, and predict timetables and expenses. Employers thus should discuss appropriate next steps with advisors who have a nuanced understanding of not only employment taxes but also of tax-refund litigation conducted in the federal district courts against the U.S. Department of Justice’s Tax Division.