Compensation and Benefits Alert

FICA Refund Update

Severance Payments: Government Appeals United States v. Quality

 

In United States v. Quality Stores, Inc., 2010 U.S. Dist. LEXIS 15,825 (W.D. Mich., Feb. 23, 2010), the United States District Court for the Western District of Michigan, affirming the United States Bankruptcy Court, held that severance payments did not qualify as “wages” subject to FICA taxation.

The court specifically held that the debtor in the bankruptcy case was not liable for FICA taxes on payments made to its employees upon their termination due to downsizing. The district court expressly chose not to follow the holding of the United States Court of Appeals for the Federal Circuit in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008) (holding that severance payments are “wages” subject to FICA taxation). The 2008 decision reversed a pro-taxpayer decision of the Court of Federal Claims in CSX Corp. v. United States, 52 Fed. Cl. 208 (2002). On April 27, 2010, the United States, not surprisingly, filed its notice of appeal of the district court’s decision in Quality Stores, asking the United States Court of Appeals for the Sixth Circuit to reverse the lower court’s decision. Based on the lower court’s decision in CSX and on the Quality Stores decision, many employers that downsized filed claims or protective claims for a refund of FICA taxes based on the court’s application of the exception for “supplemental unemployment benefits” to severance payments.

The Service has recently denied refund claims and protective refund claims based on the Federal Circuit’s reversal of the Court of Federal Claims in CSX Corp. More recent refund claims based on the enhanced arguments of Quality Stores have also been denied, citing the CSX decision. Although the Service’s refund claim denial letter is short and generated with little explanation, it is clear that taxpayers have 30 days in which to appeal, sending the case to IRS Appeals. If, after the IRS Appeals Office considers the refund claim, the taxpayer and the Service remain unagreed on the refund claim, the taxpayer (or employer) has two years from the date of the taxpayer’s first denial in which to file a refund lawsuit in either the United States Court of Federal Claims or the local United States district court.

The decision of the United States Bankruptcy Court and United States District Court in Quality Stores may bolster taxpayers’ arguments in support of excluding downsizing severance payments from “wages” for FICA tax purposes. Taxpayers (and employers) must be mindful of the time within which taxpayers must make refund claims or protective refund claims and, if such claims are denied, what options are available to them.

To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. Material discussed in this tax alert is meant to provide general information and should not be acted on without professional advice tailored to your firm's individual needs. This material is copyrighted and reprinted with permission of BDO Seidman, LLP.