Sixth Circuit Affirms Quality Stores Decision on FICA Taxation of Severance Pay – Billions of Dollars in Refund Claims Are at Issue

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By Thomas M. Cryan, Jr., Esq.
Buchanan Ingersoll & Rooney, PC, Washington, DC

In a somewhat surprising decision on September 7, 2012, the Sixth Circuit affirmed the Western District Court of Michigan's holding in U.S. v. Quality Stores Inc., , 424 B.R. 237 (W.D. Mich. 2010), that severance payments made to employees pursuant to an involuntary reduction in force were not "wages" for FICA tax purposes. U.S. v. Quality Stores Inc., No. 10-1563 (6th Cir. 2012). Given the recent economic downturn, several billion dollars' worth of FICA taxes could be at issue as a result of this decision.

Without citing the decision, the Sixth Circuit closely followed the reasoning of the Court of Federal Claims decision in CSX Corporation v U.S., 52 Fed. Cl. 208 (2002). In that case, the Court of Federal Claims concluded that involuntary layoff payments are exempt from FICA taxes, provided only that these payments qualify as "supplemental unemployment compensation benefits" ("SUB Pay") pursuant to §3402(o)(2). Although §3402(o)(2) covers income tax withholding, not FICA taxes, the Sixth Circuit concluded that any statutory exemption from "wages" like that provided for these involuntary severance benefits must be deemed to extend to FICA taxes, as well, unless the IRS provides a different rule by regulation, citing favorably the Supreme Court's decision in Rowan Cos. v. U.S., 452 U.S. 247 (1981). Although the Sixth Circuit acknowledged that Congress permitted the IRS to decouple the definition of "wages" for FICA tax and federal income tax withholding purposes when it amended the Social Security laws in 1983, the Sixth Circuit noted that the IRS had failed to issue the necessary regulations in this case.

This initial decision in CSX sparked hundreds of thousands of refund claims by employers trying to recoup the employer and employee FICA taxes paid on all forms of involuntary severance. These claims were largely held in abeyance by the IRS while the appeal was pending. In CSX Corporation v. U.S., 518 F.3d 1328 (Fed. Cir. 2008), the Federal Circuit reversed the Court of Federal Claims on this issue. The Western District Court of Michigan's decision in Quality Stores caused a second of round of refund claims by taxpayers. The IRS's procedure following the district court's decision, however, was to reject the refund claims and then agree to an extension of the two-year statute of limitation that taxpayers have to file suit in court, pending final resolution of this case. See §6532.

With the Sixth Circuit's decision in Quality Stores, there is now a split in the circuits on this issue, and taxpayers should, therefore, consider filing FICA tax refund claims for the open years for FICA taxes paid and withheld on severance payments made to employees pursuant to an involuntary reduction in force. Although the IRS is likely to issue a nonacquiescence to Quality Stores and petition the United States Supreme Court for certiorari, the final resolution of this issue will likely take several years. The statute of limitations for filing a refund claim for severance payments made in 2009 closes on April 15, 2013. See §6513(c).

For more information, in the Tax Management Portfolios, see Allman, 392 T.M., Withholding, Social Security and Unemployment Taxes on Compensation, and in Tax Practice Series, see ¶5440, Employment Tax Withholding Requirements.

© 2012 Buchanan Ingersoll & Rooney PC