On September 7, 2012, the U.S. Court of Appeals for the Sixth Circuit affirmed the Western District Court of Michigan's holding in U.S. v. Quality Stores Inc., that severance payments made to employees pursuant to an involuntary reduction in force were not "wages" for FICA tax purposes. With the current economic situation and continuing business downsizings, several billion dollars' worth of FICA taxes could be at issue as a result of this decision.
The Sixth Circuit followed the reasoning of the Court of Federal Claims decision in CSX Corporation v U.S. In that case, the Court of Federal Claims held that involuntary layoff payments are exempt from FICA taxes, if those payments qualify as "supplemental unemployment compensation benefits" ("SUB Pay") pursuant to §3402(o)(2) of the Internal Revenue Code. Although §3402(o)(2) applies to income tax withholding, not FICA taxes, the Sixth Circuit concluded that any statutory exemption from "wages" like that provided for the involuntary severance benefits must be deemed to extend to FICA taxes, as well, unless the IRS provides a different rule by regulation.
The Court of Federal Claims' decision in CSX resulted in thousands of refund claims by employers trying to recoup the employer and employee FICA taxes paid on all forms of involuntary severance. Those claims were put on hold by the IRS while the appeal in CSX was pending. The Federal Circuit Court of Appeals reversed the Court of Federal Claims on this issue.
The District Court's decision in Quality Stores caused a second of round of refund claims by taxpayers. The IRS's procedure following the district court's decision, however, has been to reject the refund claims and then agree to an extension of the two-year statute of limitation that taxpayers have to file suit in court, pending final resolution of Quality Stores in the courts.
With the Sixth Circuit's decision in Quality Stores, there is now a split in the federal circuit courts of appeal on this issue. Employers who made substantial severance payments in 2009 (or later years) should consider filing protective claims for refund by the April 15, 2013 deadline (April 15, 2014 for 2010 payments, etc.). Employers, however, may want to continue to withhold and pay over FICA taxes on severance payments until further guidance is issued by the Internal Revenue Service or the United States Supreme Court.
The process for filing a protective claim for refund is straightforward (using Form 941-X for the applicable period), and the claim does not need to be filed until just prior to the running of the statute of limitations.
The IRS is likely to issue a nonacquiescence to Quality Stores and petition the United States Supreme Court for review. Thus, the final resolution of this issue is likely several years away.
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