Following a major new development on the coverage of severance pay under Federal payroll tax (FICA) rules, affected employers should consider filing protective tax refund claims with the IRS.
A 2012 Federal Court of Appeals decision in the 6th Circuit concluded that severance payments made by Quality Stores were not subject to FICA taxes. As a result of this decision, a refund of over $1 million in FICA taxes was ordered to be paid to the employer and affected employees. (New York and New England jurisdictions are covered by case law precedent in the 2nd and 1st Circuit Courts of Appeal.)
The 6th Circuit case was based on prior Supreme Court decisions and language in the Internal Revenue Code related to supplemental unemployment benefit plans (SUB plans and trusts) that were originally created under collective bargaining agreements. The severance payments made by Quality Stores were not collectively bargained and were not paid under a classic SUB plan or a SUB trust. Nonetheless, the 6th Circuit found that the severance payments in question met the definition of a SUB plan and ordered the IRS to refund the FICA taxes that were initially paid on the severance benefits.
The Quality Stores decision is inconsistent with a 2008 decision by the U.S. Court of Appeals for the Federal District concerning severance payments made by CSX Corporation. In that case, similar severance payments were ruled to be subject to FICA taxes. By agreeing to hear the Quality Stores case in its current term, the U.S. Supreme Court will resolve this inconsistency in Federal law. The decision will likely be announced around mid-year in 2014.
Because the statutory provisions in the Internal Revenue Code have not changed in recent years, an employer that paid out severance amounts in 2010 or later may have a valid refund claim if the Supreme Court upholds the Quality Stores decision. The statute of limitations will preclude some refund claims, and the time to claim a refund for FICA taxes paid for the 2010 tax year will expire generally on April 15, 2014. So, if you are an employer that paid out severance amounts in 2010 or later, and paid FICA taxes on those payments, it may make sense to file a protective refund claim on or before April 15, 2014. The employer’s share of FICA taxes is 6.2% of covered wages and 1.45% of all wages, which can add up quickly when applied to one or more severance payments (depending on other covered wages paid prior to the severance payment). Employers that paid severance benefits in connection with a group reduction-in-force or group separation incentive program could be eligible for significant refunds.
We will be following this case carefully over the coming months. It is likely to be big news in some corners when the decision comes out.