United States: Federal Appeals Court Holds That Supplemental Unemployment Compensation Benefits Are Not ‘Wages’ Subject To FICA Taxation, Creating Circuit Split

Last Updated: April 19 2013
Article by Robert S. Hertzberg, Mike Reed and Lisa B. Petkun

Overview

In an important recent decision, United States v. Quality Stores, Inc., et al., Case No. 01-1563, 2012 U.S. App. LEXIS 18820 (6th Cir. Sept. 7, 2012), the U.S. Court of Appeals for the Sixth Circuit held that supplemental unemployment compensation benefits (SUB payments) paid by a bankrupt company to its former employees were not wages subject to taxation under the Federal Insurance Contributions Act (FICA). Accordingly, the employer and its former employees were entitled to refunds of amounts paid to the Internal Revenue Service (IRS) on account of FICA taxes from severance payments that had been made after the employer filed for bankruptcy. The Sixth Circuit declined to follow a contrary 2008 decision on the issue of the Federal Circuit, CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), the only other court of appeals decision to address the issue. The refund claim at issue in Quality Stores totals approximately $1 million (plus interest); it is estimated that similar pending refund claims total over $4 billion.

A reduction in federal tax liability is obviously beneficial to both employer and employee taxpayers. The Quality Stores decision could be especially beneficial to lower wage employees for whom FICA taxes constitute a major portion of their federal tax liability. Elimination of FICA tax liability would also increase the disposable income available to employees already suffering reduced earning prospects as a result of being laid off.

From the employer standpoint, the reduced FICA tax liability would free up money for deployment elsewhere in the enterprise at a time when funds may be tight. Employers who made severance payments to involuntarily terminated employees during the last few years could be affected by the decision. Thousands of companies are believed to have filed protective refund requests totaling $4 billion or more. Taxpayers should be aware of both a three-year statute of limitations to file a refund claim and a two-year statute of limitations for bringing a lawsuit after the denial of a refund request. It appears that many taxpayers have filed refund requests within the statute of limitations period to ensure that such requests were timely filed. It is believed that the IRS has been inundated with refund claims and, therefore, may not have processed the claims and communicated with taxpayers about the status of such claims in an orderly fashion. As a result, some taxpayers may be unaware that their refund requests have been denied because they may not have received notice of the denial. In such a case, the taxpayer may be unaware that the two-year period is running. Where lawsuits have been filed, the government reportedly has moved to stay the action pending the outcome of the Quality Stores litigation.

Quality Stores not only created a conflict among the federal courts of appeal on the applicability of FICA taxes to SUB payments, but it also raised a number of other important issues, including the level of deference to be afforded to IRS revenue rulings; the continued validity of the Supreme Court's decision in Rowan; Cos v. United States; the impact of the so-called "decoupling amendment" (discussed below) on Rowan; and the Treasury's ability to change the treatment of SUB payments under FICA through Treasury regulations.

Background

Quality Stores, Inc. was the largest agriculture-specialty retailer in the country. In October 2001, Quality Stores and its affiliates filed Chapter 11 petitions, closed all of its stores and distribution centers, and terminated all of its employees. In addition, Quality Stores made severance payments to those employees whose employment was involuntarily terminated pursuant to severance plans that did not tie the payments to the receipt of state unemployment compensation, nor were the payments attributable to the provision of any particular services by the employees.

Because the severance payments constituted gross income to the employees for federal income tax purposes, under a special statutory provision, Quality Stores reported the payments as wages on W-2 forms and withheld federal income tax. Quality Stores also paid the employer's share of FICA tax and withheld each employee's share of FICA tax. The IRS contended that most SUB payments constitute wages subject to FICA tax, except for SUB payments that satisfy an eight-factor test established in certain IRS revenue rulings—including a requirement that the payments be tied to the receipt of state unemployment compensation benefits. Although Quality Stores collected and paid the FICA tax, it did not agree with the IRS that the severance payments constituted wages for FICA purposes. Quality Stores took the position that the severance payments were not wages subject to FICA tax.

Therefore, in September 2002, Quality Stores timely filed with the IRS refund claims on behalf of itself and certain of the former employees seeking the refund of all of the amounts paid for FICA tax, totaling approximately $1 million. After the IRS failed to allow or deny the refund claim, Quality Stores commenced an adversary proceeding in the bankruptcy court to recover the refund in June 2005. The parties stipulated that, to the extent that the refund claim was allowed, Quality Stores would also be entitled to recover interest on the claim.

Lower Court Decisions

In February 2008, the bankruptcy court ruled in favor of Quality Stores, holding that the claimants were not liable for FICA taxes and were entitled to a refund. In its opinion, the bankruptcy court relied, in part, upon the decision of the Court of Federal Claims in CSX Corp., Inc. v. United States, 52 Fed. Cl. 208 (Fed. Cl. 2002). However, subsequent to the bankruptcy court's decision, the Federal Circuit issued its decision in CSX, reversing the Court of Federal Claims. Based upon CSX, the government moved for reconsideration of the bankruptcy court's decision. In August 2008, the bankruptcy court granted the government's motion for reconsideration but declined to follow the Federal Circuit's decision in CSX and ratified its prior decision. The government appealed the bankruptcy court's decision to the district court. In February 2010, the district court also declined to follow CSX and affirmed the bankruptcy court. In April 2010, the government appealed to the Sixth Circuit.

Origin of SUB Payments

In its opinion affirming the lower courts, the Sixth Circuit noted that the concept of SUB payments first appeared during the 1950s, evolving from the demand by organized labor for a guaranteed annual wage. SUB plans were developed to assure workers of employment security regardless of the number of hours actually worked, rather than to provide employees with additional compensation for work performed. When employers began adopting plans under collective bargaining agreements to fund trusts for the purpose of making SUB payments to employees in the event of unexpected job layoff or termination, it was critical that SUB payments not be characterized as "wages." If SUB payments constituted wages, then unemployed workers could not qualify for unemployment benefits under most states' laws, and the unavailability of unemployment benefits would largely defeat the purpose of SUB payments.

Definitions of 'Wages' and 'SUB Payments'

Congress imposed the FICA tax on employee wages to fund the Social Security and Medicare programs. The employer collects the employee's share by deducting the tax from wages as they are paid. The employer also pays a matching tax on the wages paid to the employee. Congress defined "wages" for FICA tax purposes (with certain exceptions) as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash ...." "Employment," for purposes of FICA, means "any service, of whatever nature, performed ... by an employee for the person employing him." For purposes of income tax withholding, the Internal Revenue Code ("IRC") contains a nearly identical definition of "wages." In Rowan Cos. v. United States, 452 U.S. 247 (1981), the Supreme Court held that Congress intended the term "wages" to carry the same meaning for purposes of both FICA and federal income tax withholding.

The withholding tax provisions of the IRC contain the following definition of "SUB payments":

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 includable in the employee's gross income. 26 U.S.C. §3402(o)(2)(A).

SUB Payments Are Not Wages

The parties had essentially stipulated that the severance payments made by Quality Stores satisfied this statutory definition. The Sixth Circuit noted that the IRC provides that a SUB payment "shall be treated as if it were a payment of wages" for purposes of the withholding tax provisions. The court found that the necessary implication arising from this phrase is that Congress did not consider SUB payments to be "wages," but allowed their treatment as wages to facilitate federal income tax withholding for taxpayers. The court further found that Congress's intention that SUB payments not constitute wages was supported by the legislative history. Thus, the Sixth Circuit concluded that, even though SUB payments are treated as wages for purposes of income tax withholding, all of such payments actually constitute non-wages. Moreover, because Rowan requires that the term "wages" be given the same meaning for purposes of FICA and income tax withholding, the court held that all SUB payments also constitute non-wages for purposes of FICA.

Sixth Circuit Rejects the Government's Other Arguments

The Sixth Circuit rejected the government's argument that Congress had legislatively superseded Rowan when it enacted the so-called "decoupling amendment" as part of the Social Security Amendments of 1983. That amendment, as written, authorized the Treasury Department to promulgate regulations to provide for different exclusions from "wages" under FICA than under the income tax withholding provisions. But, the court noted, the Secretary of the Treasury has never promulgated any regulations under the decoupling amendment.

The Sixth Circuit also rejected the government's argument that Rowan was eroded by the Supreme Court's decision in Environmental Defense Fund v. Duke Energy Corp., 549 U.S. 561 (2007). On this point, the Sixth Circuit agreed with the reasoning of the Federal Circuit, which in CSX held that Duke Energy did not affect the continuing validity of Rowan. The Sixth Circuit also rejected the government's argument that the Supreme Court's decision in Mayo Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704 (2011), undercut the validity of Rowan. In Mayo Found., the Supreme Court concerned itself with Rowan's status as a case decided before Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984), which accorded less deference to a Treasury regulation than is now required under Chevron. However, the court held that Mayo Found. added nothing of significance to the legal analysis in the present case.

Sixth Circuit Declines to Follow the Federal Circuit

The Sixth Circuit's holding that Rowan remains good law was consistent with the Federal Circuit's decision in CSX. However, the Sixth Circuit disagreed with one significant aspect of the Federal Circuit's decision in CSX. The Federal Circuit in CSX had confined the congressional definition of SUB pay in IRC § 3402(o) to federal income tax withholding only and did not rely on Rowan to conclude that the same statutory definition applies to FICA tax. The Sixth Circuit disagreed with this analysis, finding it to be inconsistent with other authority in the Federal Circuit. The Sixth Circuit relied on Rowan to reach the conclusion that if Congress decided that all SUB payments are non-wages for purposes of federal income tax withholding, then all SUB payments are also non-wages for purposes of FICA.

Revenue Rulings Did Not Control Decision

Finally, the Sixth Circuit found that the revenue rulings relied upon by the government did not alter its opinion. The court held that it would not accept the government's argument, which would have given greater significance to the IRS's revenue and private letter rulings than to congressional intent as expressed in the statutory language and legislative history.

Subsequent Developments

On October 18, 2012, the government filed a petition for rehearing en banc and on December 14, 2012, the appellees filed a response opposing the government's petition. If the petition is granted, the panel's decision will be reviewed by all of the judges in regular active service on the Sixth Circuit. If the petition is denied, many observers expect the government to ask the U.S. Supreme Court to review the decision and believe there is a good chance that the Court would accept the case for review. However, it is also possible that the government will not seek to have the Supreme Court review the case but rather will continue to litigate the issues in other circuits. In the meantime, Quality Stores will provide strong support to taxpayers seeking refunds of FICA taxes paid in connection with the many workforce reductions that have occurred during the Great Recession.

This article was published in Shopping Center Legal Update

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Lisa B. Petkun
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.