[authors: Wendi L. Kotzen, Christopher A. Jones]
In United States v. Quality Stores, Inc., the Sixth Circuit held that payments of supplemental unemployment benefits (SUB payments) are not taxable wages subject to FICA tax withholding. Although the issue is not finally settled, billions of dollars in refund claims are at issue. Employers should evaluate their refund opportunities.
FICA taxes are imposed on certain "wages" paid to employees for services performed. Under the Internal Revenue Code (the Code), SUB payments do not constitute the payment of wages. Nevertheless, specific rules in the Code require income tax withholding from SUB payments. The Code is silent on the treatment of SUB payments for FICA tax purposes. Under the Code, a SUB payment is any payment that is (i) paid to an employee, (ii) paid pursuant to an employer plan, (iii) paid as the result of an employee’s involuntary separation from employment, (iv) paid as the result of a reduction in force, the discontinuance of a plant or operation, or other similar conditions, and (v) includible in the employee’s gross income.
Since at least 1990, the IRS has held the position that, even though SUB payments are non-wage payments, SUB payments are wages for FICA purposes unless such payments are specifically designed to supplement state unemployment benefits. In CSX Corp. v. United States, decided in 2008, the Federal Circuit agreed with the IRS that SUB payments are subject to FICA taxes.
In Quality Stores, the company remitted FICA taxes on payments that the company and the IRS agreed were SUB payments. The company’s payments to its terminated employees were not connected to any state unemployment compensation and were not attributable to any specific service performed by the employees. The Sixth Circuit disagreed with the Federal Circuit's decision in CSX and held that, because the SUB payments were not wages under the Code for federal income tax purposes (even though they were subject to federal income tax withholding), the SUB payments also were not wages for FICA tax withholding. Because no special Code rule applies to require FICA withholding from non-wage SUB payments, the SUB payments paid by Quality Stores were not subject to FICA tax withholding.
The Sixth Circuit's decision in Quality Stores creates a split in the Circuits and confusion in the current state of the law. The IRS may seek rehearing by the Sixth Circuit or petition for certiorari to the U.S. Supreme Court. At an American Bar Association Section of Taxation meeting in September, an IRS spokesperson advised that the IRS generally will maintain that SUB payments are subject to FICA taxes; additionally, we understand that the government expects to appeal to the U.S. Supreme Court.
Quality Stores now is the law in the Sixth Circuit (Michigan, Ohio, Tennessee, and Kentucky). Employers whose principal place of business is in those states should consider seeking refunds of FICA taxes they remitted for SUB payments since January 1, 2009. Also, Sixth Circuit employers should consider whether to withhold FICA taxes from SUB payments made since Quality Stores. Those employers should keep in mind that, if Quality Stores ultimately is overturned, they would owe back FICA taxes for all periods for which the statute of limitations for assessment is open.
Employers in other states are advised to continue withholding FICA taxes from SUB payments (other than payments designed to supplement state benefits) and to consider filing protective claims no later than April 15, 2013, for refunds of FICA taxes withheld and paid on SUB payments made since January 1, 2009, to preserve the statute of limitations. (Generally, the limitations period for a refund claim of FICA taxes is three years from April 15 of the calendar year following the year in which the SUB payments were made).
Before a refund claim can be perfected, an employer must determine the exact amount of FICA tax paid to the IRS (both the employer's share and the employee's share). Additionally, the employer must make a reasonable attempt to obtain each employee’s consent authorizing the employer to file a claim on the employee’s behalf. A protective claim can be filed, however, without employee consent, and an employer who files such a claim can perfect it at a later date depending on how the split in the Circuits is resolved. Therefore, the burden of filing a protective claim for refund is relatively low and should be considered by employers who made SUB payments since January 1, 2009.
The IRS likely will hold protective refund claims in abeyance until Quality Stores is resolved. If the IRS denies a refund claim filed by an employer, however, such employer must either file suit within two years of the mailing date of the claim disallowance, or seek an agreement from the IRS to extend the time for filing suit. Since the CSX decision was issued, the IRS has been agreeing to such extensions so that the issue can be resolved while refund claims are pending.
For questions about the Quality Stores decision, filing a protective claim for refund, or other employment tax issues, please contact Wendi L. Kotzen at 215.864.8305 or firstname.lastname@example.org, Christopher A. Jones at 215.864.8424 or email@example.com, or another member of Ballard Spahr's Tax Practice Group.