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September 19, 2012

Court of Appeals Agrees that Severance Payments Are Not Subject to FICA (article)

The Sixth Circuit Court of Appeals has affirmed a district court decision that severance payments made to employees pursuant to an involuntary separation from employment due to a reduction in workforce are not subject to FICA taxes. Employers that have been forced to downsize their workforce in the current economy should consider filing protective refund claims to recover these taxes. As the IRS likely will appeal the decision to the Supreme Court, employers should continue to subject severance payments to FICA taxes (and subsequently file protective refund claims) until the issue is ultimately resolved.

The Sixth Circuit's decision in U.S. v. Quality Stores, Inc., CA-6, 2012-2 USTC ¶50,551 (Sept. 7, 2012) reinforces the district court's conclusion that supplemental unemployment compensation benefits (SUBs) are merely treated as if they were wages for income tax withholding purposes under IRC Section 3402(o) and are not actually wages, and thus, are not subject to FICA taxes. In reaching its conclusion, the Court looked to the legislative history of §3402(o) as well as to its very title – "Extension of withholding to certain payments other than wages." For more information on the original district court decision, see our March 2010 Tax Alert, "Possible Refunds of FICA Tax Paid on Severance Payments."

Resolution of this issue is far from complete. The Sixth Circuit's opinion is in direct contrast to the Federal Circuit Court of Appeals' decision in CSX Corp. v. U.S., 518 F.2d 318 (Fed. Cir. 2008). The IRS has also issued several rulings wherein only certain types of SUBs were exempt from FICA taxation, such as those that are conditional on the employee's receipt of unemployment compensation benefits. Given the large amount of taxes at stake, the IRS likely will file an appeal of this decision to the U.S. Supreme Court which, if the case is accepted, will drag out the issue's ultimate resolution for a number of years.

In the meantime, employers that paid FICA taxes on severance payments due to a reduction in workforce should file protective refund claims before the statute of limitations expires on those tax liabilities. The statute of limitations on filing the claim for credit or refund is 3 years from April 15 following the year in which the relevant quarter falls or the year ends, or 2 years from the date the tax was paid, whichever is later. Therefore, if an employer paid FICA on qualifying severance payments to employees in 2009, the employer generally has until April 15, 2013 to file a refund claim.

The claims must be filed using Form 941-X or 945-X to correct errors previously made on the Form 941 (Employer's Federal Quarterly Tax Return) or Form 945 (Employer's Federal Annual Tax Return). To file for both the employer and employee portions of the FICA, you must certify that you reimbursed your employee or secured his consent to allow the claim for refund, or after reasonable efforts, have been unable to do so.

The IRS will not grant any refund claims until the issue has been resolved, but filing the refund claim within the statute of limitations will protect your rights to the refund should the issue ultimately be decided in the taxpayer's favor. The potential refunds, which would include interest on the taxes paid, could be significant.

To determine whether you qualify for this refund opportunity or for assistance with filing the necessary claims for refund, contact your local CBIZ MHM tax professional.

Copyright © 2012, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. To ensure compliance with requirements imposed by the IRS, we inform you that-unless specifically indicated otherwise-any tax advice in this communication is not written with the intent that it be used, and in fact it cannot be used, to avoid penalties under the Internal Revenue Code, or to promote, market, or recommend to another person any tax related matter. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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