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Next Steps for Employers Regarding the FICA Tax Treatment of Severance Pay; HIPAA Omnibus Rule Impacts Group Health Plans; San Francisco Health Care Security Ordinance Enforcement Initiative

Focus On Employee Benefits

Employment Taxes: Update - Next Steps for Employers Regarding the FICA Tax Treatment of Severance Pay Following the Sixth Circuit’s Affirmance of Quality Stores

Marianna Dyson and Michael Lloyd

In September 2012, the U.S. Court of Appeals for the Sixth Circuit affirmed the decisions of the bankruptcy and district courts for the Western District of Michigan in United States v. Quality Stores, Inc., 693 F.3d 605 (6th Cir. 2012). 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 narrowly defined 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. Further, the Sixth Circuit criticized the government for its "failure to promulgate [FICA] regulations to implement the 'decoupling amendment.'"

On January 4, 2013, the Sixth Circuit denied the government's request for an en banc rehearing of this decision. 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 strong candidate for Supreme Court review. A petition for certiorari is currently due on April 4, 2013. If a petition is filed and the Supreme Court agrees to hear the case, a decision resolving the controversy would likely issue in the first half of 2014. A failure to file by the government would be indicative of a strategy to contest the issue in the other federal circuits, which would perpetuate the uncertainty for much longer.

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).

(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.

  • IRS Service Centers are formally denying FICA tax refund claims based upon the Quality Stores case, if filed by employers located outside of the Sixth Circuit. A denial starts the two-year period of limitations within which a refund action must be brought.
  • FICA tax refund claims filed by employers located in the Sixth Circuit (i.e., Kentucky, Michigan, Ohio, and Tennessee) are currently being held in suspense by IRS Service Centers.

(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. Many employers have already been issued a Notice of Claim Denial in response to FICA tax refund claims filed for 2008 and earlier years.

  • For those employers bumping up against this two-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.

Lawyers 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.

Health and Welfare: HIPAA Omnibus Rule Impacts Group Health Plans

Amy Healy and Eva McComas

On January 17, 2013, the U.S. Department of Health and Human Service (HHS) released the HIPAA Omnibus Rule, which makes changes to the Privacy, Security, Enforcement and Breach Notification Rules under the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and the Health Information Technology for Economic and Clinical Health Act (HITECH), which was enacted as part of the American Recovery and Reinvestment Act of 2009. Group health plans will be required to take action this year as the result of the significant changes to the HIPAA and HITECH rules. For example, group health plans will need to update their current Notice of Privacy Practices this year. It also will be necessary for group health plans to review and revise, if necessary, their agreements with Business Associates.

The HIPAA Omnibus Rule, which was published in the Federal Register on January 25, 2013, includes over 120 pages explaining the changes to the HIPAA and HITECH rules, as well responding to public comments that were previously submitted to HHS. The comprehensive rule sets forth different dates for compliance with the various changes.

Health and Welfare: San Francisco Health Care Security Ordinance Enforcement Initiative

Eva McComas and Gary Quintiere

San Francisco has recently signaled that employers failing to observe both the letter and spirit of its Health Care Security Ordinance (SF HCSO) will be dealt with sternly. On January 25, 2013, the San Francisco City Attorney announced an enforcement initiative against San Francisco restaurants and other businesses that imposed a customer surcharge in order to cover their costs for complying with the requirements of the SF HCSO. Although these employers followed a practice that met the requirements of the SF HCSO, the City Attorney has threatened to charge them with consumer fraud unless they agree to a settlement offer described below.

The SF HCSO, which became effective in 2008, requires certain San Francisco businesses to incur health care expenditures of a specified amount for employees who work a minimum number of hours per week. In response to the SF HCSO, some San Francisco restaurants imposed a health care surcharge on each customer's bill, such as four percent of each customer bill. According to the San Francisco Office of Labor Standards Enforcement (OLSE) Analysis of the Health Care Security Ordinance, 2011 Annual Reporting Forms, issued August 23, 2012, 172 businesses imposed a surcharge on customers' bills in 2011. These 172 businesses are five percent of the 3,652 businesses and nonprofit organizations that filed 2011 Annual Reporting Forms (ARFs). Of these 172 businesses, 101 reported that the amount of health care surcharges collected were higher than the amount they irrevocably spent on health care for their employees.

OLSE's analysis of the 2011 ARFs states that the collection of a consumer surcharge in excess of the amount of irrevocable health care expenditures is not a violation of the SF HCSO in 2011. That situation changed in 2012 when San Francisco amended the SF HCSO to provide that if an employer collects a health care surcharge greater than the amount spent on employee health care, then the employer must irrevocably pay or designate such difference for health care expenditures for its covered employees.

The City Attorney's enforcement initiative is focused on surcharges occurring during the 2009 to 2011 period. As noted above, prior to 2012, it was a permissible practice under the SF HCSO for an employer to impose a health care surcharge in excess of the amount spent on employee health care. The City Attorney's enforcement initiative is not based on the SF HCSO; rather it is based on the allegation that this surcharge practice constituted consumer fraud under California consumer protection laws. This allegation was the basis, in part, for the Patxi's Chicago Pizza settlement agreement, which the City Attorney released shortly before announcing the enforcement initiative.

The City Attorney has sent letters to the businesses that it has identified as the "worst offenders." Although these businesses were not identified in the initiative, they were subsequently disclosed to a news company pursuant to a public documents request. These letters provide that the businesses will not be sued by San Francisco for consumer fraud if they voluntarily take the following action:

  • The business discloses all health care surcharges and health care expenditures for the years from 2009 to 2011.
  • The business distributes 50 percent of the amount of the health care surcharges in excess of actual health care expenditures to employees who worked for the business during the time that the surcharge was imposed.
  • Any amounts distributed to employees but not redeemed by the employees will revert to San Francisco. The City Attorney has indicated that these amounts will be used for future enforcement of the SF HCSO and consumer protection laws.
  • The business must comply in good faith with the SF HCSO going forward.

The business must provide certain information to the City Attorney no later than April 10, 2013. The City Attorney will advise the business of the next steps.

The City Attorney has indicated that a business that does not participate in this settlement program risks being sued for "full restitution of the amount of surcharges collected during that period, plus up to $2,500 in penalties for each customer who was defrauded" during the years 2009 to 2011. The City Attorney also asserts that the businesses risk liability for all costs and attorneys' fees incurred by San Francisco in the consumer fraud lawsuit.

The City Attorney's enforcement initiative is supported by the Golden Gate Restaurant Association (GGRA), which is the trade association for the San Francisco Bay Area restaurant industry. The GGRA's prior challenge to the legality of the SF HCSO was not successful.

The City Attorney's enforcement initiative is a reminder of the importance of compliance with both the complex SF HCSO and California consumer protection laws. It is a strong signal to employers that San Francisco will challenge any practice that it believes falls short of delivering the required health benefits to covered employees under the SF HCSO.


For more information, please contact:

Gary Quintiere,, 202-626-1491

Marianna Dyson*

Michael Lloyd*

Eva McComas*

Amy Healy*

*Former Miller & Chevalier attorney

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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