Archive for September 10th, 2012

In a case with far-reaching implications — including the potential for refund claims to be filed by any employer making severance payments to terminated employees during the recent economic downturn — the Court of Appeals for the Sixth Circuit concluded on Friday that severance pay pursuant to an involuntary layoff was not subject to FICA employment taxes.

First, a bit of history: The treatment of certain supplemental unemployment compensation benefits (“SUB”) for FICA purposes has long been clouded. SUB payments were created in the 1950s as a way to supplement the state unemployment compensation benefits received by employees upon involuntary termination, and were defined in Section 3402(o) as amounts:

1) Which are paid to an employee, 2) Pursuant to an employer’s plan; 3) Because of an employee’s involuntary separation from employment, whether temporary or permanent, 4) Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and 5) Are Included in the employee’s gross income. [Ed note: this will encompass most involuntary severance payments.]

These SUB payments have always been subject to federal income tax withholding by virtue of that same Section 3402(o), which provides that for purposes of determining whether a SUB payment is subject to withholding, it “shall be treated as if it were a payment of wages by an employee to an employee for a payroll period.”

In the most important court decision on this issue prior to last Friday, the Court of Appeals for the Fifth Circuit had concluded in CSX Corporation v. United States, 518 F.3d 1328 (5th Cir., March 2008), that this language did not mean that SUB payments were treated as wages only for purposes of determining whether they were subject to federal income tax withholding. Rather, the court held that SUB payments were also wages for purposes of FICA taxes, stating:

…because we have rejected the first part of CSX’s argument-that the reference to the term “wages” in section 3402(o) necessarily implies that all payments falling within the definition of SUB in that subsection are non-wages, we reject CSX’s statutory argument.   Based on that analysis, we disagree with the trial court’s conclusion that all payments that qualify as SUB under the statutory definition in section 3402(o)(2)(A) are non-wages for purposes of FICA. We therefore reverse those portions of the trial court’s judgment that were based on the trial court’s adoption of that theory of the case.

On Friday, the 6th Circuit took a different approach, and reached a different conclusion, in Quality Stores, Inc. v United States, holding that severance payments were not subject to FICA.

Quality Stores was an agricultural-specialty retailer who filed for Chapter 11 during 2001. Prior to November, 2001, Quality Stores involuntarily terminated 75 employees, with all remaining employees terminated after November 2001 when Quality Stores closed its doors and went out of existence.

As part of the severance packages offered by Quality Stores, employees were paid based on years of service, and the payments were not tied to the receipt of any state unemployment compensation.Because SUB payments clearly represent income that is subject to federal income tax withholding pursuant to Section 3402(o), Quality Stores reported the payments on the recipients’ Forms W-2, and remitted over $1,000,000 in FICA tax to the IRS. Soon after, Quality Stores filed a claim of refund for the FICA taxes, arguing that the severance payments were not subject to FICA as they were not “wages” for those purposes.

In an initial hearing, a bankruptcy court ruled in favor of Quality Stores in 2005, and late last week, the 6th Circuit affirmed the bankruptcy court’s decision, holding that the SUP payments were not wages subject to FICA tax.

The 6th Circuit reached its conclusion by first looking to the legislative history of Section 3402(o). When the provision was enacted in 1969, Congress recognized that SUB payments “are not subject to federal income tax withholding because they do not constitute wages or remuneration for services.” Because SUB payments represent taxable income to the recipient, however, Congress wanted to take the income tax burden of the recipient by requiring withholding at the source, adding:

Although these benefits are not wages, since they are generally taxable payments they should be subject to withholding to avoid the final tax payment problem for employees.

Having established that SUB payments were not wages for federal income tax purposes, the Sixth Circuit then looked to prior case law, which held that Congress intended for the definition of wages for federal income tax and FICA purposes to be one and the same.[i]

Congress imposed federal income tax withholding on SUB payments because they qualify as gross income, not because they are “wages.” Reading the definitions of “wages” found in the FICA and federal income tax statutes consistently, SUB payments do not constitute “wages” under either statutory scheme.

What’s the lesson? With the Fifth and Sixth Circuit Court of Appeals disagreeing on such an impactful issue, the determination of whether SUB severance payments are wages subject to FICA is likely heading to the Supreme Court. In the meantime, it may behoove any employers who recently paid FICA tax on SUB payments to file a  protective claim for refund.

[i] See Rowan Cos. v. United States, 452 U.S. 247 (1981)

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We’ll hit this weekend’s roundup in a moment, but first,  a public service announcement: At the risk of sounding unpopular, with the dawn of a new NFL season, please allow me to remind you that regardless of what you may think, no one — and I mean no one — cares about your fantasy football team.

On to the tax stuff…

As you may have heard, the Democrats threw their once-every-four-year soiree last week, and despite what The Onion might have said, the DNC involved more than just applauding the image of a dead Osama bid Laden for three hours. No, there was some actual tax policy discussion going on, and now that both the Republicans and Democrats have finished their little pep rallies, the interwebs are rife with reaction from tax eggheads:

The Tax Foundation crafted this analysis comparing Romney and Obama’s tax plans to the one devised by the Simpson-Bowles Commission, a bipartisan group established in 2010 and charged with recommending a tax plan that would simplify the Code while reducing the national deficit. The conclusion? While neither plan mirrors that of the Commission, Romney’s proposals — if politically possible to implement — come much closer to meeting the Simpson-Bowles goals of cutting rates and eliminating deductions in a manner that leads to a decreased deficit, economic growth, and a simplified tax code.

Next, Howard Gleckman over at the Tax Policy Center sums up both conventions — and bipartisan politics in general — wonderfully by pointing out that both Romney and Obama spent all of their time taking issue with the other candidate’s plans, neglecting to ever clarify the proposals for tax reform they would enact if elected.

Lastly, David Johnston at Reuters published a scathing column attacking the tax goals of the Romney-Ryan campaign, arguing that the Republican income tax proposals would further enrich the super wealthy while nearly doubling the income tax burden of the middle class, while their push to remove the estate tax would create a nation of dynasties that would have a devestating effect on economic growth.

In non-convention news, Kelly Erb over at Forbes has this tidbit: Hustler Magaizine publisher Woody Harrelson Larry Flynt is offering $1,000,000 cash for the unpublished Romney tax returns. Wonder why he hasn’t just brokered a deal with these guys?

Finally, allow me to send you off into the workweek with this wonderful montage of the slow transformation of Breaking Bad’s Walter White from mild-mannered chemistry teacher to ruthless meth kingpin. [May not be safe for work. Unless you work in a meth lab, in which case it should be fine.)

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