On September 7, 2012, the United States Court of Appeals for the Sixth Circuit ruled in favor of the taxpayer regarding severance payments made to former employees – these are not wages for FICA tax purposes and thus, are except from FICA tax. The Sixth Circuit has jurisdiction over Ohio, Kentucky, Michigan, and Tennessee.
Many companies who have downsized have provided severance payments to former employees. Traditional supplemental unemployment benefit payments ("SUB pay") are not classified as wages for FICA purposes and are not subject to 7.65% FICA taxes to be paid by the employer. The IRS had historically treated severance payments as wages and subject to FICA taxes. However, the Sixth Circuit ruled in United States v. Quality Stores, Inc. that severance payments fell within the definition of SUB pay under Section 3402(o) of the Internal Revenue Code, a statute specifically related to income tax withholding, not FICA taxes.
This recent Quality Stores case, while only binding in the Sixth Circuit, creates a split in the circuit courts. In March 2008, the Federal Circuit Court of Appeals ruled in CSX Corporation v. United States that severance payments must meet the requirements set forth in Revenue Ruling 90-72 to be exempt from FICA.
While resolution on this issue could be several years away, it is likely the IRS will appeal this decision to the Supreme Court. Employers in the Sixth Circuit who have provided severance payments should consider filing protective refund claims. A protective refund claim is filed when a refund is contingent on future events and may not be determinable until after the time period for filing a claim for refund expires. A protective claim preserves a taxpayers right to claim a refund when the contingency is resolved. These claims will be held in suspension by the IRS pending a final resolution on this issue.
Have questions about filing a protective refund claim? Contact our Tax Planning & Preparation Services Group at 440-449-6800.