March 21, 2010
Employers Who Paid Out Severance May Be Entitled to FICA Refund: Protective Refund Claims for 2006 Payments Due April 15, 2010
A new case out of the Western District of Michigan held that severance payments made in connection with an involuntary reduction in force or layoff are not "wages" subject to Federal Insurance Contributions Act (FICA) taxes (Social Security, Medicare). Although this decision is only binding precedent in Michigan, employers who paid out severance in 2006 should consider filing protective refund claims by this April 15 to preserve their rights.
The case is In re Quality Stores, Inc., --- B.R. ----, 2010 WL 679136 (W.D. Mich. Feb. 23, 2010). Quality Stores brought an adversary proceeding against the United States, seeking a refund of approximately one million dollars of FICA taxes paid on severance payments to former employees, arguing that these payments were not subject to FICA because they were not "wages." The Court agreed.
The IRS Code broadly defines "wages" as "all remuneration for employment." “Employment” is defined as “any service . . . by an employee for the person employing him." In turn, the IRS imposes the FICA tax to fund Social Security and Medicare on employees' "wages." Thus, the crucial question for the Court was whether the severance payments were "wages" within the meaning of the statute. The Court determined that these payments were not wages.
The reasoning is as follows. The Internal Revenue Code (IRC) says that for purposes of tax withholding, severance benefits are to be treated “as if they were wages.” Obviously, this language would not be necessary if severance pay actually was wages. Therefore, with no parallel directive regarding severance and FICA, the court concluded that severance is not wages and need not be treated as wages in terms of paying FICA contributions.
This decision is contrary to 1990 IRS Guidance, (Rev. Rul. 90-72), which advised that only payments linked to the employee's receipt of unemployment compensation and not paid in a lump sum were excluded as "wages" subject to FICA. The Court also considered and rejected the more recent contrary ruling from the Federal Circuit: CSX Corp. v. United States, 518 F.2d 318 (Fed. Cir. 2008).
Although it may ultimately be determined that the Michigan Court was in error (and no refunds will be issued), claims for a refund for payments made in 2006 will be time-barred if they are not filed by April 15. (The statute of limitations is three years from the April 15 after the tax year.) Therefore, in order to preserve any claim you may have for refunds, you should speak with your tax professional about filing for a refund.
Please contact Thomas Doyle with any questions.