United States: Sixth Circuit Denies Rehearing Of FICA Tax Severance Pay Case

The Sixth Circuit Court of Appeals has denied an IRS request for an en banc rehearing of its decision in United States v. Quality Stores, Inc. (No. 10-1563), which held that certain severance payments were not subject to payroll taxes under the Federal Insurance Contributions Act (FICA). The IRS now has until May 31, 2013, to appeal the decision to the Supreme Court.

FICA generally subjects all wages to matching employer and employee contributions for Social Security and Medicare taxes. The IRS has long argued that severance payments made at the separation of service are wages for FICA tax purposes, and the Federal Circuit agreed with the IRS in CSX in 2008. But the Sixth Circuit ruled in Quality Stores that supplemental unemployment benefits (SUB) payments, as defined under Section 3402(o), are not subject to FICA. SUB payments are generally defined as amounts paid to an employee because of an involuntary separation of employment due to a reduction in work force, the discontinuation of a plant or operation, or other similar conditions.

Section 3402(o) provides that SUB payments should be treated "as if they were wages" for income tax withholding purposes. The taxpayer in Quality Stores successfully argued that this rule implies that SUB payments are not actually wages and that there is no corresponding rule to treat them as if they were wages for FICA tax purposes.

Employers with pending protective claims (or other potential refund claims for open years) in the Sixth Circuit still need to wait for the case to be fully resolved before obtaining a refund. Many taxpayers outside the Sixth Circuit have also filed protective claims, but the IRS has largely denied these claims based on the 2008 decision from the U.S. Court of Appeals for the Federal Circuit in CSX Corp. v. United States (518 F.3d 1328). These taxpayers need to monitor their two-year window for filing suit and should file Form 907 to extend their deadlines when necessary.

Taxpayers who have not yet filed protective claims should consider doing so, but taxpayers outside the Sixth Circuit should wait as long as possible in order to postpone the start of their window for filing suit after a denied claim.

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