United States: Sixth Circuit Denies IRS Request To Rehear Decision Upholding Refund For FICA Taxes On Certain Severance Payments

The Sixth Circuit Court of Appeals has denied an IRS request for an en banc rehearing of its decision in United States v. Quality Stores, Inc. (No. 10-1563), which held that certain severance payments were not subject to payroll taxes under the Federal Insurance Contributions Act (FICA). The IRS now has 90 days from Jan. 4 to appeal the decision to the Supreme Court.

Employers with pending protective claims (or other potential refund claims for open years) in the Sixth Circuit still need to wait for the case to be fully resolved before obtaining a refund. Many taxpayers outside the Sixth Circuit have also filed protective claims, but the IRS has largely denied these claims based on the 2008 decision from the U.S. Court of Appeals for the Federal Circuit in CSX Corp. v. United States (518 F.3d 1328). These taxpayers need to monitor their two-year window for filing suit and should file Form 907 to extend their deadlines when necessary.

Taxpayers who have not yet filed protective claims should consider doing so, but those outside the Sixth Circuit should wait as long as possible in order to postpone the start of their window for filing suit after a denied claim.


FICA generally subjects all wages to matching employer and employee contributions for Social Security and Medicare taxes. The IRS has long argued that severance payments made at the separation of service are wages for FICA tax purposes, and the Federal Circuit agreed with the IRS in CSX in 2008. But the Sixth Circuit has now ruled in Quality Stores that supplemental unemployment benefits (SUB) payments as defined under Section 3402(o) are exempt from FICA. SUB payments are generally defined as amounts paid to an employee because of an involuntary separation of employment due to a reduction in work force, the discontinuation of a plant or an operation, or other similar conditions.

Section 3402(o) provides that SUB payments should be treated "as if they were wages" for income tax withholding purposes. The taxpayer in Quality Stores successfully argued that this rule implies that SUB payments are not actually wages and that there is no corresponding rule to treat them as if they were wages for FICA tax purposes.

Next steps

If the case is not appealed to the Supreme Court (or if the Supreme Court declines to hear it), employers located in Kentucky, Michigan, Ohio and Tennessee (states in the Sixth Circuit) should be able to successfully execute refund claims for FICA taxes on SUB payments. For employers outside these states, it is more complicated. The IRS has been denying protective refund claims outright based on the CSX decision, and the IRS may continue to argue that if the Supreme Court does not take up Quality Stores, CSX remains the controlling decision in all other jurisdictions. Under this scenario, taxpayers would likely begin challenging CSX in other jurisdictions.

A Supreme Court decision should settle the issue completely allowing refunds for taxpayers in all jurisdictions or for no one. But a Supreme Court decision ruling could still be a long time coming, and challenges in other circuits (if the Supreme Court does not hear the case) could take years to resolve. So, taxpayers in all circuits should consider filing protective refund claims. Taxpayers outside of the Sixth Circuit should keep in mind that their claims are likely to be denied and the two-year window to file suit starts as soon as they receive the notice of denial. The statute of limitations to file a protective refund claim for 2009 (all four quarters) does not expire until April 15, 2013, so taxpayers can still wait for several months before filing a protective claim to keep 2009 open.

Responding to a denied claim

A protective claim is contingent on a future event that may not be determinable until after the time period for filing a claim expires. The IRS will generally delay action on a protective claim until the contingency is resolved but has been denying protective claims made outside the Sixth Circuit by arguing that CSX is settled and controlling in all other jurisdictions.

Taxpayers who have received or will receive a notice of disallowance on a protective claim have four options:

1. File an administrative appeal with the IRS within 30 days after the notice is issued.

2. Request the IRS to reconsider the disallowance in light of the Quality Stores ruling.

3. Bring a lawsuit immediately against the IRS.

4. Reserve the right to file suit in federal court (i.e., wait and see).

The first and second options appear unlikely to succeed. Taxpayers with a significant refund at stake who believe they could receive a favorable decision in their district court or their circuit can consider bringing suit themselves. But most taxpayers should wait and preserve their protective claim while the cases develop. Even if the Supreme Court does not take up Quality Stores, the IRS position is likely to be challenged in other circuits. Taxpayers have only two years from the date of receipt of an IRS notice of disallowance to file suit in federal court to seek an order overturning the IRS's decision, but can file Form 907 when this deadline approaches. The IRS must accept and sign Form 907 for the form to be effective and has generally been accepting two-year extensions.

Filing a FICA refund claim

FICA protective refund claims may be filed without notifying the affected employees. To file an actual refund claim (rather than a protective claim) for the employer's share of FICA tax, however, the employer must first make a reasonable attempt to notify the affected employees of the availability of the refund and offer to file a refund claim on behalf of the employees for the employees' share of FICA tax. To file a refund claim on the employee's behalf, the employee must provide the employer with a written statement certifying that the employee will not file a refund claim directly with the IRS and also provide written consent for the employer to file the refund claim on the employee's behalf. If employees cannot be located and/or do not provide their written consent, the employer may file a refund claim for just the employer's share of FICA tax.

To ultimately file an actual refund claim, employee wage information must be preserved. Because it may take several years for the appeals process to conclude, employers should act now to maintain and preserve the wage information necessary to file actual refund claims.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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