In a pro-taxpayer decision, the Sixth Circuit Court of Appeals found that Federal Income Contribution Act (FICA) taxes should not have been imposed on certain severance payments because the payments were supplemental unemployment benefits, not wages. In allowing the refund of more than $1 million in FICA taxes paid, the court looked at the statutory language, rather than prior IRS rulings on the issue. (Both the former employees and the employer were entitled to refunds for their shares of the FICA tax withheld on the severance payments.)
As a result of the In re Quality Stores, Inc., employers and employees in Kentucky, Minnesota, Ohio and Tennessee, the states in the Sixth Circuit Court of Appeals, can file for a refund of overpaid FICA taxes if the payments meet the Court's test for severance payments and the refund period has not run.
Requirements for refund. Not every severance payment will be considered a supplemental unemployment benefit (SUB) payment. In order to qualify, the following conditions must be met:
- The employer had a plan in place that provided for severance payments.
- The employee's separation from service was involuntary (but it need not have been permanent).
- The involuntary separation was due to a downsizing or the closing of a plant or operation.
- The payments were included in the employee's gross income.
Not only must these four requirement be met, the claim for refund must be made before the three-year limitation period expires. The three years start to run when the employment tax return is filed. FICA taxes are reported quarterly and the return is due on the last day of the month following the close of the quarter (April, July, October and January of the next year.)
October 31, the deadline for filing a claim for refund for the July-September quarter of 2009, is rapidly approaching. (The limitations period has already run for any employees who separated from service prior to July 2009.) Use Form 843, Claim for Refund and Request for Abatement and its instructions to file the refund claim. The time period for filing a claim with regard to employees separated during the fourth quarter of 2009 will run on January 31, 2013.
The Sixth Circuit decision is binding law only on the states under its appellate jurisdiction. The Quality Stores decision is at odds with a 2008 Federal Circuit Court of Appeal case which agrees with the IRS that such payments are wages subject to FICA taxes. This conflict may set the stage for the United States Supreme Court to rule on the issue. In the interim, employers and employees in other states may file for a refund of overpaid taxes, but should expect a serious battle from the IRS if they do so.
If you believe you meet the requirements for non-taxable severance payments, you may wish to file what is known as a protective refund claim. As the name suggests, this filing will serve to protect your rights should the limitations period be about to expire. Before embarking on this strategy, though, you should consult with an experience tax professional who is familiar with all the facts of your business and can evaluate what are your best options.