The U.S. Supreme Court resolved a split among lower courts regarding whether severance payments under a severance plan are subject to FICA, overruling the holding of the Sixth Circuit Court of Appeals in the case of United States v. Quality Stores, 113 AFTR 2d 2014-1326 reversing CA6, 110 AFTR 2d 2012-5827. The IRS, nearly eleven months later, officially announced [Announcement 2015-8] that based on that decision the agency was going to deny all pending claims for refund.
The District Court for the Western District of Michigan in United States v. Quality Stores weighed in the question of whether severance payments made under a severance plan are subject to FICA taxes, disagreeing with the conclusion of the Federal Circuit Court of Appeals in CSX Corp. v. United States, 518 F.3d 1328, 101 AFTR 2d 2008-1120, (Fed. Cir. 2008). The Michigan court concluded that the payments are not subject to FICA, being properly treated as supplemental unemployment compensation benefits (“SUB” pay).
The IRS position, stated in Revenue Ruling 90-72, is that such a program only qualifies for an exemption the pay must be linked to the receipt of state unemployment benefits and not paid in a lump sum. However, the Michigan District Court, sustaining the prior holding of the Bankruptcy Court that was appealed to it, found that while IRC had the authority under §3121(a) to issue regulations treating such a payment as wages, the IRS had not done so, but rather simply issued the Revenue Ruling.
Given that no regulations had been written, the Court felt the wording of §3402(o) that said such payments shall be treated as “if they were wages” for purposes of income tax withholding implied that they were not otherwise wages—and thus not subject to FICA. Thus the Court held that the Bankruptcy Court had properly decided that Quality Stores was due a refund of FICA taxes paid on the payments.
The Sixth Circuit Court of Appeals sustained the position of both lower courts when the IRS appealed the case before it, refusing to accept the IRS’s ruling as the final word on the law. The appellate court did note that the matter likely would need to be decided by the U.S. Supreme Court given the split in the Circuits, as the Federal Circuit had reached exactly the opposite conclusion in the 2008 decision in CSX Corp. v. United States, 101 AFTR 2d 2008-1120.
Supreme Court Decides the Issue
It turns out that the Sixth Circuit’s crystal ball was clear on this issue, since the U.S. Supreme Court granted the government’s petition for certiorari on October 1, 2013 and in March of 2014 overturned the Sixth Circuit’s ruling in an 8-0 unanimous ruling (Justice Kagan, who was involved in the matter previously in her former position as U.S. Solicitor General, did not take part in this decision).
The Supreme Court refused to take the view, noted above, that IRC §3402(o) effectively meant that severance payments generally were not wages, and that the provision only “pretended” they were wages for income tax purposes. The Court implicitly criticizes the Sixth Circuit’s analysis, noting that the Court relied upon an income tax withholding provision rather than looking the specific (and broad) specific definition of wages for FICA purposes in the Code.
The Courts notes that merely stating an amount shall be treated “as if” the amount were wages (the wording of IRC §3402(o)) does not mean the item would not be wages if the provision were not there. The Court goes on to note that IRC §3402(a) was enacted to deal with a specific problem dealing with supplemental unemployment benefits negotiated by various unions in specific industries to provide the equivalent of a guaranteed wage.
Some states’ unemployment programs provided that no payment would be made to any person receiving wages from an employer—so the IRS took the position that such “SUB” payments were not wages for FICA purposes. While solving this problem, it also meant the employees ended up substantially underwithheld at year end, so Congress enacted §3402(o) to allow for wage withholding from these “not wages” to solve that program.
The Supreme Court noted:
Once this background is understood, the Court of Appeals' interpretation of § 3402(o) as standing for some broad definitional principle is shown to be incorrect. Although Congress need not have agreed with the Revenue Rulings to enact § 3402(o), its purpose to eliminate the withholding problem caused by the differential treatment of severance payments is the necessary background to understand the meaning and purpose of the provision. The problem Congress sought to resolve was the prospect that terminated employees would owe large payments in taxes at the end of the year as a result of the IRS' exemption of certain SUBs from withholding. It remained possible that the IRS would determine that other forms of SUB plans, perhaps linked differently to state unemployment benefits, should be exempt from withholding. If Congress had only incorporated the Revenue Rulings already in effect, that response may have risked the withholding problem arising once again. On the other hand, by drawing a withholding requirement that was broader than then-current IRS exemptions, Congress avoided these practical problems. A requirement that a form of remuneration already included as wages be treated "as if " it were wages created no administrative difficulties.
So at this point we now have a resolution to the issue of FICA taxation of such severance programs—they are subject to the tax.
Announcement 2015-8 and Pending Claims
In February of 2015 the IRS officially announced how it would handle the numerous claims for refund that had been filed with the agency prior to the Supreme Court decision, when taxpayers, using the logic endorsed by the Sixth Circuit (but finally rejected by the Supreme Court), asked for refunds of employment taxes paid on severance payments.
Outside of the Sixth Circuit the IRS had been denying such claims. If taxpayers filed an appeals request with the Office of Appeals the IRS would suspend action on the appeal pending the resolution of the Quality Stores case. For taxpayers located within the jurisdiction of the Sixth Circuit the IRS would not deny the claim, but would simply suspend the claim rather than deny the claim.
The IRS will now disallow all claims for refund that do not fit the narrow exception found in Revenue Ruling 90-72 discussed above. Thus, the claims that had been in suspense in the Sixth Circuit will now move forward with a denial of the claim.
The IRS will also take no further action on the cases for which an appeal has been filed. If the taxpayer believes the case involves issues other than those resolved in Quality Stores, the announcement provides that taxpayers should contact Laird MacMillan at (651) 726-1473 for information on proceeding with those other issues that are part of the claim.
If a taxpayer who has a “suspended” case at Appeals does not contact the IRS, the IRS will take no further action on the case. As the IRS notes in Announcement 2015-8:
As stated in the disallowance letter sent to taxpayers claiming a refund, the two-year period during which the taxpayer may file suit in a United States district court or the United States Court of Federal Claims began on the date the disallowance letter was mailed by certified or registered mail. The filing of an appeal request did not suspend that time period for filing suit.
Advisers who have taxpayers with such claims at appeals should have been tracking that date for filing suit. If the case involves a claim that is not resolved by Quality Stores, consultation with the client and counsel should take place as soon as possible, if it has not already taken place. Depending on the time left to run on the statute, it may still be possible to resolve the other issues at appeals and, if so, likely contacting the IRS at the number provided above is the next step.
For those located in the Sixth Circuit there will be more time to act on the claims, as they will only now be formally denied, thus beginning the starting of the two year clock on filing legal action. If the claim involves issues not resolved by Quality Stores the taxpayer may wish to file an appeal, though care will need to be taken to make it clear the appeal involves issues other than those decided by the United States Supreme Court. Contacting the IRS employee noted above would be advisable in these cases to determine how to keep the case from being one that the IRS simply takes no action on pending the running of the statute on filing a court action regarding the agency’s denial of the claim.