The IRS may owe FICA tax refunds on severance payments made by employers to laid-off or terminated employees as part of reductions in workforce. Every employer that paid severance to laid-off employees as part of a reduction in workforce in 2009 or later years needs to consider filing FICA tax refund claims.The Sixth Circuit held that certain types of severance pay, known as "supplemental unemployment compensation benefits" or "SUB payments," are not subject to FICA tax. United States v. Quality Stores, Inc., No. 10-1563 (6th Cir. September 7, 2012). The Sixth Circuit Court, rejecting the definition of SUB payments advanced in IRS revenue rulings, held that the definition of SUB payments in Internal Revenue Code § 3402(o) controls, specifically not following the Federal Circuit's decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).
Expect the government to either ask the Sixth Circuit for rehearing or, if the government does not ask or the Sixth Circuit denies the request, ask the United States Supreme Court to overturn the Sixth Circuit, as the Sixth and Federal Circuits do not agree. Short of a decision by the Supreme Court, expect the government to continue to litigate this issue in other circuits in an attempt to avoid paying millions of dollars of refund claims.
In order to meet the definition of a SUB payment under Internal Revenue Code § 3402(o), the payments must be: (1) made to an employee; (2) made pursuant to an employer plan; (3) made because of an employee's involuntary separation from employment (whether or not such separation is temporary); (4) made as a direct result of a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee's gross income.
Employers that made severance payments in 2009 meeting the § 3402(o) definition of SUB payments should consider filing claims for FICA tax refunds. While the IRS is likely to continue to deny these refund claims and litigate this issue, employers with potential refund claims must file claims prior to the expiration of the statute of limitations. The statute of limitations for filing FICA tax refund claims for timely filed 2009 Forms 941 expires on April 15, 2013. Whether employers should file claims for refund for years after 2009 depends upon the ultimate resolution of the issue.
In addition, until this issue is finally resolved, employers should continue to withhold and remit FICA taxes on severance pay (including employers with employees in the Sixth Circuit (Kentucky, Michigan, Ohio, and Tennessee)). The IRS' current position is clear. Employers are liable for 100 percent of the FICA taxes, and there is little or no recourse against former employees for their share of the FICA taxes. Employers can subsequently file refund claims after final resolution of this issue.
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