October 02, 2013

Supreme Court Will Decide Whether FICA Tax Applies to RIF Severance Pay

The United States Supreme Court has granted certiorari to review the Sixth Circuit's decision in Quality Stores, which held that severance payments in connection with a reduction in force (RIF) are exempt from Social Security (FICA) taxes. United States v. Quality Stores, Inc., 693 F.3d 605 (6th Cir. 2012). Employers who have made similar payments should file refund claims as a protective measure in the event the Supreme Court upholds the Sixth Circuit's decision

As we have previously discussed in our September 2012 and March 2010 legal updates, there is a split of authority on whether some types of severance pay are exempt from Social Security taxation. In 2002, the Court of Federal Claims held that an exemption existed if the requirements in section 3402(o) of the Internal Revenue Code were met: (1) an amount was 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) the amount was included in the employee's gross income. CSX Corporation v. United States, 52 Fed. Cl. 208 (2002).

However, the Federal Circuit reversed that decision. It agreed with the IRS that the exemption exists only if the severance payments were designed to supplement state unemployment benefits — generally meaning that the payments were made in installments and were conditioned on the individual's ongoing eligibility for state unemployment benefits. CSX Corporation v. United States, 518 F.3d 1328 (Fed. Cir. 2008). Severance payments generally do not qualify for the exemption under that test.

Last year, the Sixth Circuit disagreed with the Federal Circuit in Quality Stores, a decision that went in favor of the taxpayer. The immediate impact of Quality Stores was limited to states in the Sixth Circuit: Kentucky, Ohio, Michigan and Tennessee. But the Supreme Court's decision to review Quality Stores means that there will now be a uniform rule across the country.

Employers who have made severance payments pursuant to a plan because of a reduction in force should strongly consider filing refund claims, which is done using IRS Form 941-X. The statute of limitations for post-2009 quarterly tax periods is open. The limitations period for 2010 quarterly tax periods terminates on April 15, 2014. Because Quality Stores most likely will be decided after that date, the refund claims should be filed on a protective basis.

We have assisted taxpayers in filing protective refund claims for earlier years. Indeed, many such claims were filed following the initially favorable CSX decision. If a taxpayer has filed such a claim and received a notice of disallowance from the IRS within the last two years, consideration should be given to requesting from the IRS an extension of time to bring a refund suit, which generally is done on IRS Form 907. The statute of limitations to file a refund suit in court following a disallowance is generally two years. Form 907 can extend that period. Another way to keep the statute open (if the IRS declines to agree to a Form 907) is to file a refund suit.

Some employers filed protective claims years ago prior to the Federal Circuit's 2008 adverse decision in CSX. If these claims were never disallowed, they should still be valid claims. Taxpayers should review their files to confirm the status of any such claims as either pending or disallowed, and take appropriate action to preserve their rights.

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