Sixth Circuit Denies Government Motion for Rehearing in Quality Stores Employment Tax Challenge

The Sixth Circuit has unanimously and summarily denied a Government request for en banc rehearing of a taxpayer-favorable ruling in United States v. Quality Stores, Inc., 693 F.3d 605 (6th Cir. Sept. 7, 2012). In the prior ruling (which we explained in a prior alert), a Sixth Circuit panel ruled that payments made to separated employees pursuant to supplemental employment compensation plans (SUB payments) do not constitute "wages" subject to FICA. According to the Government, taxpayers have paid approximately $1 billion in FICA on SUB payments in recent years, and many of those taxpayers could be entitled to refunds.

The technical legal issue in Quality Stores, whether the Section 3402(o) exclusion of SUB payments from the definition of wages for withholding purposes also applies to the definition of wages for FICA purposes, has been the subject of litigation for many years. Previously, the Federal Circuit had reached the opposite result in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), concluding that SUB payments should be treated as "wages" for FICA purposes. The CSX and Quality Stores decisions address essentially the same arguments and both courts acknowledged that the statutory construction issue is close. Nonetheless, the two decisions have created a direct circuit conflict.

The ruling is unlikely to be the last word on the issue and the ultimate outcome of the litigation involving the taxation of SUB payments for FICA purposes is still unknown. The Government may still file for certiorari in the Supreme Court until early April -- a distinct possibility given the amount at issue and the conflicting court of appeals rulings. Whether the Government will seek Supreme Court review, and (if so) whether the Supreme Court will agree to hear the case, will not be known for several months.

We understand that the IRS has stopped processing refund claims filed by taxpayers asserting the Quality Stores theory in the Sixth Circuit (Ohio, Michigan, Kentucky and Tennessee). Unless the IRS obtains a grant of certiorari in the Supreme Court, and reversal of the ruling in Quality Stores on the merits, however, it will be required to start processing refunds for taxpayers in the Sixth Circuit. We understand that the IRS is still denying similar claims filed by taxpayers in other circuits. Those taxpayers may have to wait for further developments in the case law or for the IRS to announce a formal change in position accepting some or all of the Sixth Circuit's analysis. Regardless, it is unlikely that the government will allow disparate treatment of taxpayers in different circuits to continue for long.

In the interim, affected taxpayers should continue to protect themselves from statute of limitations issues by filing refund claims for all open years asserting that the Quality Stores reasoning applies to SUB payments. Even if the IRS audits and formally rejects the claims, taxpayers will still have two years to file suit, by which time the uncertainty in the law should be resolved.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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