Opportunity for FICA Savings on Severance
A recent U.S. District Court case for the Western District of Michigan may give employers authority to file for refund claims of FICA (Social Security) taxes on severance pay and to avoid FICA taxation on future severance pay. The case, decided by a district court in the Sixth Circuit, is United States v. Quality Stores, Inc., 2010 U.S. Dist. LEXIS 15825 (2010). While its reasoning is technical, the court essentially concluded that "supplemental unemployment compensation benefits" are not subject to FICA. According to the court, supplemental unemployment compensation benefits are taxable amounts paid to an employee under an employer's plan on an employee's involuntary separation from employment because of a reduction in force, the discontinuance of a plant or operations, or other similar conditions. The separation from employment can be temporary or permanent. Under this definition, layoff or severance benefits paid under a plan in connection with an event such as a reduction in force or discontinuance of operations can be excluded from FICA, whether the benefits are paid in a lump sum or in installments.
Benefits paid to an employee who continues to work reduced hours or under an individually negotiated severance package would remain subject to FICA.
In 2002, the U.S. Court of Federal Claims reached a similar conclusion in a decision that was overturned by the U.S. Court of Appeals for the Federal Circuit in 2008. The lower court decision resulted in many employers filing protective claims for FICA tax refunds. Those were held in abeyance pending the Federal Circuit court appeal and presumably were all ultimately denied.
Based on this new decision, employers may again want to file protective claims for FICA tax refunds. The IRS may hold the refund claims in abeyance or could choose to deny them. If the IRS denies a claim, an employer will have to sue for a refund within two years of the denial. The IRS is likely to appeal the Quality Stores decision to the U.S. Court of Appeals for the Sixth Circuit.
Employers who have paid severance in connection with substantial layoffs may wish to file refund claims for FICA taxes paid on severance payments that meet the definition of "supplemental unemployment compensation benefits." Employers could also consider not paying FICA on severance pay that meets the "supplemental unemployment compensation benefits" definition on a going forward basis. However, because the IRS has not accepted this decision, an employer taking that position would want to consult counsel about penalties associated with the position and the employer's obligation to disclose the position on its payroll tax returns.
The statute of limitations for FICA tax returns for calendar year 2006 is set to expire on April 15, 2010. Employers wanting to file a refund claim for that year must do so before the April 15 deadline.