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Potential Significant FICA Refund Opportunity On Severance Payments

October 9, 2012

In light of a recent decision by the U.S. Court of Appeals for the Sixth Circuit, employers should be acting now to claim (or preserve their rights to claim) refunds of FICA tax previously paid on severance payments. The rules in this area are complex, but with appropriate guidance, a claim could have substantial value to you if this decision stands.

Employers and employees both pay FICA tax on severance payments, unless the payments are “supplemental unemployment compensation benefits.” IRS rulings and some prior court decisions narrowly defined the severance payments qualifying as supplemental unemployment compensation benefits exempt from FICA, requiring that the payments be made at the same time as, and, as a supplement to, State unemployment benefits received by the discharged employee.

On September 7, 2012, however, the U.S. Court of Appeals for the Sixth Circuit in the Quality Stores case adopted a very broad definition of “supplemental unemployment compensation benefits,” under which many types of severance payments to employees involuntarily discharged due to a reduction in force, the discontinuance of a plant or operation, or other similar circumstances are exempt from FICA. The Court held that payments under two severance plans of Quality Stores, Inc. were supplemental unemployment compensation benefits exempt from FICA. The Court found this to be the case regardless of whether employees were receiving State unemployment benefits, and even though one of the plans provided for lump sum severance payments.

The IRS could request a rehearing by the Sixth Circuit of its decision in the Quality Stores case and/or request that the U.S. Supreme Court resolve the opposing positions of the Court of Appeals for the Sixth Circuit and for the Federal Circuit. But this decision governs the law in Michigan and much of the mid-west until the Supreme Court decides otherwise.

There are complex rules that apply to FICA refund claims, relating to the time within which such claims must be made, the forms which must be used, and a requirement that employees consent in writing to the employer seeking a refund of the employee portion of FICA. Making a FICA refund claim entails substantial work (depending upon the number of employees involved). However, some of that work can be deferred if the employer currently files a protective refund claim within the required limitations period and then perfects the claim when the judicial process is completed. Nevertheless, there are also complex rules that must be complied with to make an effective protective refund claim. There are also complex rules and procedures employers must address in the event the IRS disallows their FICA refund claims, including a requirement that refund litigation be instituted within a prescribed period following the disallowance (unless the employer complies with specific procedures for obtaining IRS consent to an extension of such time period). Employers must also address complex issues in deciding how to handle severance payments going forward.

Honigman Miller Schwartz and Cohn LLP can assist employers in filing FICA refund claims and in litigation, as well as in addressing all of the complex associated issues. Please contact one of the Honigman attorneys listed on this alert for such assistance.