The Sixth Circuit's Affirmance of Quality Stores Splits the Circuits as to the FICA Tax Treatment of Severance Pay -- Next Steps for Employers?

Tax and Employee Benefits Alert

The U.S. Court of Appeals for the Sixth Circuit has finally issued its decision in United States v. Quality Stores, Inc., No. 10-1563 (6th Cir. Sept. 7, 2012), which affirms the decisions of the bankruptcy and district courts for the Western District of Michigan. The court held that payments made by an employer to its employees upon involuntary termination due to business cessation did not constitute wages for purposes of the Federal Insurance Contributions Act ("FICA"). In so doing, the Sixth Circuit expressly noted that it did not agree with the Federal Circuit's approval of the IRS's position that payments falling within the statutory definition of supplemental unemployment compensation benefits ("SUB pay") can still be treated as dismissal pay subject to FICA taxes in CSX Corp. v. United States, 518 F.3d 1328 ( Fed. Cir. 2008).

This split between the Sixth Circuit and the Federal Circuit over the FICA tax treatment of SUB pay is based, largely, on differences in each court's view of whether and how section 3402(o) of the Internal Revenue Code – the provision requiring income tax withholding on SUB payments as if they were "wages" – should be applied for FICA tax purposes when the Code is actually silent on the issue of FICA tax treatment. In its interpretation of section 3402(o), the Sixth Circuit concluded that Congress intended to extend federal income tax withholding to payments "other than wages" when it enacted the provision. The court reasoned that since SUB payments are not "wages" under the general definition of "wages" subject to income tax withholding, such payments are not "wages" for FICA tax purposes, relying on the Supreme Court's decision in Rowan Cos. v. United States, 452 U.S. 247 (1981), for the proposition that the term "wages" has the same meaning under the FICA tax provisions as it does for federal income tax withholding purposes. The court specifically rejected the government's argument that intervening legislation, known as the decoupling amendment, makes Rowan no longer good law for this proposition and, consequently, the payments must qualify as SUB pay as defined in in Rev. Rul. 90-72, 1990-2 C.B. 211, and Rev. Rul. 56-249, 1956-1 C.B. 488, in order to escape FICA taxation. The court also rejected the government's contention that the Supreme Court's recent decision in Mayo Foundation for Medical Ed. & Research v. U.S., 131 S. Ct. 704 (2011), had undermined the authority of Rowan.

We believe that the government is likely to seek further review in this case. Given the clear circuit conflict, the important issue concerning the interpretation of the Rowan decision and the subsequent decoupling amendment, and the administrative complications that will arise without a uniform rule, this case is certainly a candidate for Supreme Court review. A petition for rehearing before the Sixth Circuit is due on October 22 and a petition for certiorari is currently due on December 6 if the government does not seek a rehearing.

In the interim, what should an employer do?

  1. Regardless of the circuit in which the employer resides, we are advising our clients to continue withholding FICA taxes on severance payments otherwise satisfying the requirements of section 3402(o) until we know whether Supreme Court review will occur.
  2. The employer may also want to consider filing refund claims with the IRS before the three-year period of limitations expires. For employment taxes withheld and paid in calendar year 2009, the three-year period will expire on April 15, 2013, for employers who timely filed their Forms 941. A decision to file a protective refund claim for later years may be deferred for the time being.
  3. If the IRS has denied an employer's refund claim for an earlier calendar year, the law provides that an employer has two years in which to file a refund action either in the U.S. District Court or the U.S. Court of Federal Claims. For those employers bumping up against this 2-year deadline, we are recommending that they consider filing a Form 907, "Agreement to Extend the Time to Bring Suit," with the IRS, following the very specific instructions for preparation, submission and execution. Of course, if the IRS has not yet denied the employer's refund claim, the two-year period has not begun to run and a Form 907 would not be necessary.

Attorneys in Miller & Chevalier's Employee Benefits group have filed hundreds of these claims over the years and, therefore, we have developed an efficient and cost-effective procedure to assist employers with this endeavor. Please let us know if we can be of assistance.

For additional information, please contact any of the following lawyers:

Marianna Dyson,, 202-626-5867

Michael Lloyd,, 202-626-1589

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