In part one of this two-part series, “The Advantages of Offering Supplemental Unemployment Benefits Instead of Severance, Part I: FICA Taxes and More,” I reviewed the advantages of offering supplemental unemployment benefits plans. In the second part of this series, I discuss the differences between supplemental unemployment benefits plans and severance plans and the impact that the Quality Stores decision might have on the future of supplemental unemployment benefits plans.
How Do Severance Plans Differ from SUB-Pay Plans? What about Quality Stores?
Usually, severance pay:
is not linked to the receipt of state unemployment benefits;
may be paid in a lump sum or installments for the length of the severance period;
is subject to income, FICA, and FUTA taxes; and
in most states reduces and/or eliminates the amount of unemployment benefits a former employee may receive from the state.
IRS Info 2013-0023 (dated May 31, 2013 and released on June 28, 2013) provides more information on the taxation of severance. However, in United States v. Quality Stores, Inc., the Sixth Circuit Court of Appeals held that severance paid to employees pursuant to a plan on account of an involuntary reduction in force is not subject to FICA taxes, creating a split among the circuit courts on this issue. Significantly, the Quality Stores decision does not require that severance payments be tied to the employee’s receipt of unemployment compensation benefits and does not distinguish between periodic or lump sum payments. In effect, the Sixth Circuit’s ruling rejects the additional limitations imposed by the IRS on SUB-Pay and represents a substantial expansion of the types of involuntary severance that are exempt from FICA.
Given the uncertain future of the Quality Stores decision, employers should continue to pay and withhold FICA taxes on involuntary severance benefits that are not provided pursuant to a traditional SUB-Pay Plan. Any employer that paid and withheld FICA taxes on severance paid in 2010 and subsequent years on account of involuntary reductions in force or layoffs should consider filing refund claims for FICA taxes based on Quality Stores. In my March 2013 blog post, “April Deadlines Relating to FICA Tax Treatment of Severance Pay in Quality Stores Are Quickly Approaching,” I describe the process employers must follow to file a FICA-tax refund claim and what employers can expect after filing the claim.
There are two significant updates of which employers should be aware since that post was published. First, the federal government filed its long-awaited certiorari petition in Quality Stores on May 31, 2013. The petition asks the Supreme Court of the United States to review the Sixth Circuit’s ruling that severance payments paid to employees pursuant to a plan on account of an involuntary reduction in force are not “wages” for FICA tax purposes. Counsel for Quality Stores filed a brief in opposition to the government’s petition on July 30, 2013 and in August, the case was distributed to the justices for review at conference and the United States filed its reply to Quality Stores’s brief. Because of the Supreme Court’s summer recess, a decision on whether to grant certiorari will not be announced before October.
Second, the statute of limitations for filing protective refund claims with respect to qualifying severance paid in 2009 and prior years has expired. Employers may now only file protective refund claims for qualifying severance paid in 2010 and subsequent years. The IRS has stated that it is suspending FICA tax refund claims from taxpayers within the Sixth Circuit and denying FICA tax refund claims from all other taxpayers. However, in order for any employer to protect its right to a future refund based on Quality Stores, the employer must file a refund claim.
Future of SUB-Pay?
Regardless of what happens in Quality Stores, there are unique benefits to providing traditional SUB-Pay. The benefit of providing traditional SUB-Pay to employees is that the receipt of SUB-Pay does not generally impact an employee’s eligibility for, or amount of, state unemployment benefits. The benefits to the employer flow from coordinating SUB-Pay with state unemployment benefits—allowing employers to provide benefits on a periodic basis (e.g., reducing cash flow impact), tax savings for employers (and also employees), and more.
Because of these benefits, SUB-Pay is popular in many industries. Historically, SUB-Pay was typical in the automotive, manufacturing, and steel industries because SUB-Pay was first recognized in the 1950s as a result of union negotiations intended to augment state unemployment benefits. However, SUB-Pay can be and is used today by employers in all industries. For example, I’ve assisted employers in the financial, insurance, lending, and legal industries with the design, state approval process, and implementation of their SUB-Pay plans and trusts.