If the recent decision of the Sixth Circuit Court of Appeals in United States v. Quality Stores survives appeal by the IRS, employers could be entitled to a refund of FICA taxes paid by them after 2008 on severance payments relating to plant closings, reductions in force, discontinuances of operations and other similar events. In order to preserve their right to a refund for 2009 and after should the decision survive appeal, employers must file a protective refund claim with the IRS before the statute of limitations for filing a FICA refund claim for a year expires. The statute generally is April 15 of the fourth year following the year for which the FICA payment was made. Thus, a refund claim for 2009 FICA taxes must be filed by April 15, 2013, the deadline for 2010 FICA taxes is April 15, 2014 and so on. Refund claims filed after the running of the statute will be denied automatically.
The Sixth Circuit Court of Appeals in United States v. Quality Stores, Inc. (September 7, 2012), held that Quality Stores was entitled to a refund of $1,000,125 in FICA taxes on severance payments it made when the company closed 63 stores and nine distribution centers prior to entering chapter 11 bankruptcy and its remaining 311 stores and 3 distribution centers after entering chapter 11. The ruling covered a variety of severance payments types, including payments to executives and non-executive workers, as well as lump sum severance payments and severance payments paid in weekly installments. The Court held that FICA taxes were not owed on those severance payments because the payments fit within the definition of “supplemental unemployment benefits” (“SUB”) which are excepted from FICA taxation. The Court stated that for a severance payment to be a SUB it must meet five requirements: (1) an amount 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) included in the employee’s gross income.
The Quality Stores decision (even if it survives appeal) may not apply to all severance payments. The fourth requirement of a SUB payment is that the payment result “from a reduction in force, the discontinuance of a plant or operation or other similar conditions.” The Sixth Circuit did not explore the boundaries of the fourth requirement because Quality Stores involved the liquidation of a company’s 374 stores and 12 distribution centers, which clearly satisfies the fourth requirement. On its face, however, the fourth requirement appears to require a severance that results from a decision that is not related to the performance of the employee being severed. Thus, the Quality Stores decision probably does not apply to severance paid to an employee who is terminated for performance reasons or for other reasons not having to do with the financial condition of the employer.
Because the Quality Stores decision will not become final until the appellate process is completed, the IRS will not be approving any FICA tax refund claims soon--even for employers that have made severance payments of the type that clearly fall within the ambit of the Quality Stores decision. The appellate process may take several years to complete. The IRS has appealed the decision to the entire Sixth Circuit and if that appeal fails it may appeal the decision to the United States Supreme Court. If the decision survives the appeal to the entire Sixth Circuit and the IRS does not appeal to the Supreme Court, the decision will become the law in the Sixth Circuit only and employers located in Ohio, Kentucky, Michigan and Tennessee will then be entitled to a refund of any FICA taxes paid on qualifying severance payments they made during tax years that remain “open” at the time the appellate process is completed. Employers located within the other Circuits will probably have their refund claims denied by the IRS (although they could always sue for refund on the basis of the Quality Store decision). If the decision were to be upheld by the Supreme Court, the decision would become the law of the land and all employers would be entitled to a refund of any FICA taxes paid on qualifying severance payments they made during “open” tax years. Of course, if the decision is overturned, there will be no refunds for any employers.
Until the appellate process is completed, we recommend that employers with potentially significant refund claims do the following. First, because Quality Stores is not yet a “final” decision, employers should continue to pay FICA taxes on any severance payments it makes from now until the decision becomes final (“post-decision severance payments”). Second, for both post-decision severance payments and pre-decision severance payments, such employers should take the steps necessary to insure that all currently “open” tax years remain “open” until completion of the appellate process. To accomplish this, employers should, as discussed above, file “protective” refund claims by the statute of limitation date for each currently “open” tax year. The refund claims should include the broadest possible categories of severance payments, even those severance payments as to which there may be doubt on whether they satisfy the fourth requirement of SUB payments. The protective refund claim will toll the statute of limitations.
For refund claims filed by employers located within the Sixth Circuit, the IRS will most likely hold on to such claims until the appellate process runs its course and it is known whether the Quality Stores decision becomes final law or is overturned. The IRS will approve the refund claims if the decision becomes law and it will deny the claims if the decision is eventually overturned. For other employers, the IRS may hold their claims until the appeals process is exhausted or it may deny the claims sooner because they are from outside the Circuit that made the decision that is being appealed. In the latter case, the employer will still have at least an additional two years after the denial of the claim to sue for a refund in court. By that time, the appellate process may be completed and the employer can then make a decision on how to proceed based on the final outcome of the appellate process. Although it is anyone’s guess on how the appeal of the Quality Stores decision will turn out, what can be said for certain is that if an employer does not file a timely protective refund claim, there is no chance for a refund even if the decision is ultimately upheld by the Sixth Circuit and/or the Supreme Court.
Employers who may be interested in learning more about the Quality Stores decision and filing a protective claim for refund of FICA taxes may contact the author or another attorney from the Dinsmore Tax Group.