Sixth Circuit Will Not Rehear Quality Stores Decision that Severance Pay in Connection with a Reduction in Force is not Subject to FICA; Supreme Court Next Step?

by Proskauer Rose LLP
Contact

On September 7, 2012, the Sixth Circuit Court of Appeals held in United States v. Quality Stores, Inc. that severance payments to former employees pursuant to an involuntary reduction in force are not taxable "wages" for purposes of Social Security and Medicare withholding under the Federal Insurance Contributions Act, or FICA. The decision is significant in two respects. First, the Sixth Circuit chose not to follow a contrary decision reached by the Federal Circuit Court of Appeals in CSX Corp. v. United States, 518 F.3d 1328 (2008), thereby creating a split in the federal circuits that may ultimately be resolved by the Supreme Court. Second, the Sixth Circuit's pro-taxpayer decision substantially impacts unemployed workers and businesses that have reduced their workforce in recent years. On January 4, 2013, the Sixth Circuit denied the government's petition for rehearing en banc. The government has until April 4, 2013 to petition the Supreme Court to address the case.

Many employers that paid FICA taxes on involuntary severance payments in calendar year 2009 or thereafter are considering filing a protective refund claim to preserve their right to a refund pending further guidance and resolution of this issue. This Client Alert summarizes some of the key issues to consider.

Mechanics of FICA Tax Payment

FICA tax consists of both Social Security and Medicare taxes. The employer pays the employer portion to the government, withholds the equal employee portion from each employee's wages, and pays the employee portion to the government as well. Note that taxes on self-employment income are different. Self-employment income cannot be classified as wages because an employer-employee relationship does not exist between the payer and payee. In lieu of FICA tax, the Internal Revenue Code (the "Code") imposes a self-employment tax on self-employment income.

Summary of the Decision

In United States v. Quality Stores, Inc. the Sixth Circuit considered whether supplemental unemployment compensation benefits ("SUB payments") paid to employees pursuant to an involuntary reduction in force were taxable as "wages" under FICA. SUB payments are treated as wages for income tax withholding purposes. However, it is not clear that SUB payments are included in the FICA definition of "wages."

Quality Stores, Inc. ("Quality Stores") made periodic and lump-sum payments to employees involuntarily terminated in connection with the closing of hundreds of company facilities in 2001. Because the payments constituted income for federal income tax purposes, Quality Stores reported the pay on each employee's W-2 and withheld federal income tax. It also paid the employer's share of FICA tax and withheld each employee's share of FICA tax. The company subsequently sought a refund of the FICA amounts, believing that the payments made to its employees were not wages but instead constituted SUB payments that were not taxable under FICA. The Internal Revenue Service (IRS) took a contrary position, seeking to have the payments classified as "wages" for purposes of FICA withholding.

Congress defined "wages" for FICA purposes as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash . . . ." Code Section 3121(a) (emphasis provided). Although the statute does not expressly include or exclude SUB payments from the definition of "wages," the Sixth Circuit explained that "SUB pay falls outside the broad statutory meaning of service performed by an employee for an employer because, by definition, an employee is not eligible for SUB pay until service to the employer has ended and such benefits provide compensation for the lost job."

Congress expressly defined SUB payments for purposes of federal income tax withholding in Code Section 3402(o), entitled: "Extension of Withholding to Certain Payments Other Than Wages." (emphasis provided). Section 3402(o) defines SUB payments as:

"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 includible in the employee's gross income."

Relying on the Supreme Court's conclusion in Rowan Cos. v. United States, 452 U.S. 247 (1981) that Congress intended the term "wages" to carry the same meaning for purposes of FICA and federal income tax withholding, the court held that the payments made by Quality Stores to its former employees satisfied the definition provided in Section 3402(o) and the payments were therefore excludible from the definition of "wages" for FICA purposes.

The IRS urged the opposite conclusion, arguing that intervening legislation in the form of the "decoupling amendment" made Rowan no longer good law. As part of the Social Security Amendments of 1983, the decoupling amendment authorizes the Treasury Department to promulgate regulations to provide for different exclusions from "wages" under FICA than under the income tax withholding provisions. The court held that Rowan was still good law, noting that the decoupling amendment merely granted Congress the authority to promulgate these regulations but the Treasury Department has not yet done so.

The government also cited IRS revenue rulings and private letter rulings concluding that the "definition of SUB pay under section 3402(o) is not applicable for FICA . . . . [and] SUB pay is defined solely through a series of administrative pronouncements published by the Service." Rev. Rul. 90-72, 1990-2 C.B. 211. Under IRS guidance, to be exempt from "wages" under FICA, SUB payments must be made to involuntarily separated employees pursuant to a plan that is designed to supplement the receipt of state unemployment compensation and do not include payments made in a lump sum because such payments are not considered linked to state unemployment compensation. The Sixth Circuit disagreed that this IRS guidance should control the outcome in the case and noted that IRS revenue rulings and private letter rulings do not hold the same significance as Congressional intent.

The court's conclusion departs from an important decision by the Federal Circuit in CSX Corp. In CSX Corp., the Federal Circuit affirmed the Supreme Court's decision in Rowan, but did so with respect to federal income tax withholding only and did not conclude that the same statutory definition of "wages" applied for purposes of FICA tax withholding. Accordingly, the Federal Circuit held that the SUB payments in CSX Corp. were wages subject to FICA. The Sixth Circuit in Quality Stores labeled this an "inconsistency" and chose to extend the reasoning in Rowan to amounts withheld under FICA.

It is unknown whether the IRS will seek certiorari to the Supreme Court. Given the significance of the opinion, the split in the circuits, and the billion dollars claimed by the IRS to be at stake, the Supreme Court might decide to take this case if it is presented.

Impact on Employers

The Quality Stores decision represents an opportunity for employers in the Sixth Circuit (Tennessee, Michigan, Ohio and Kentucky) and potentially in other Circuits to obtain a refund for FICA taxes paid and withheld on SUB payments.

Generally, if an employer believes that FICA taxes were overpaid, the employer can file a refund claim. The refund claim is made on the employer's behalf for the employer portion and on each employee's behalf for the employee portion. Before a refund claim can be paid, the employer is required to attempt to contact each affected employee and ask for the employee's consent to pursue the refund claim on his or her behalf. When the refund claim is paid, the employer will receive the entire employer portion. The employer will also receive the employee portion for consenting employees and must distribute these funds to them.

Employers that have made SUB payments in connection with a reduction in force or a discontinuance of operations should consider filing a protective refund claim. A taxpayer may file a protective claim in situations where the statute of limitations for the refund claim may expire before the resolution of a future event. A protective claim would preserve the statute of limitations on employment tax refund claims for open years and would require later filing of a supplementary claim with necessary employee consents and exact calculations. The deadline for filing a protective claim is three years from April 15 of the calendar year following the year in which the payments were made. For example, for FICA taxes paid in 2009, a protective claim should be filed by April 15, 2013.

Additionally, employers whose claims were denied in the wake of the CSX Corp. decision should consider filing a Form 907 agreement to extend the time to bring suit with the IRS.

It is unclear at this time how the IRS will respond to refund claims. New claims filed as a result of the Quality Stores decision may be rejected by the IRS due to the split in the circuits or may be held without action. Until this controversy is resolved, it is prudent for employers to continue withholding FICA taxes on SUB payments made in connection with the present or future involuntary termination of employees that do not meet the strict definition provided in IRS Revenue Ruling 90-72 for exemption.

If you have any questions regarding the Quality Stores decision, filing a protective claim, or this client alert, please feel free to contact any of the lawyers listed in this alert.

* * *

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by U.S. Treasury Regulations, Proskauer Rose LLP informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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.

© Proskauer Rose LLP | Attorney Advertising

Written by:

Proskauer Rose LLP
Contact
more
less

Proskauer Rose LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.