PROTECTIVE FICA CLAIM FOR SEVERANCE PAYMENTS - 16 Mar 2010

MARCH 2010
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ô€˜SUBJECT
PROTECTIVE FICA CLAIM FOR SEVERANCE PAYMENTS
ô€˜SUMMARY
The application of FICA tax to severance pay in connection with certain events
such as a reduction in force or plant closing has been hotly contested in the
courts for a number of years. With the recent economic decline, many
companies have had reductions in force and plant closings and paid severance
to terminated employees. Most likely, those companies paid both the
employer’s and employee’s share of FICA on those payments. The Internal
Revenue Service has been successful in defending the government’s position
that such payments are wages subject to FICA tax.

 
Now, however, the United States District Court for the Western District of
Michigan reached a taxpayer-favorable result on the application of the FICA
tax to severance payments when it chose not to follow a 2008 ruling by the
United States Court of Appeals for the Federal Circuit in CSX Corp. v. United
States, 518 F.3d 1328 (Fed. Cir. 2008). The court ruled that the bankruptcy
court in United States v. Quality Stores Inc. correctly determined that
payments a company made to employees as part of a company’s severance
program were not subject to FICA tax. In re Quality Stores Inc., No. 1:09-cv-
44 (Feb. 23, 2010).

 
As background, the Service applies a set of strict standards for a taxpayer to
treat severance pay as exempt from FICA tax. See Rev. Rul. 90-72. Thus,
under these standards, severance pay is generally considered wages for such
purposes. However, section 3402(o) treats the payment of certain
supplemental unemployment compensation benefits (referred to as “SUB pay”)
“as if it were a payment of wages” for income tax withholding purposes.
ô€˜Read more

Taxpayers have argued that the inference to be drawn from section 3402(o) is that SUB pay is generally not treated
as wages for employment tax purposes; otherwise, the “as if it were” language would not have been necessary.

There is no corollary provision in section 3121 to exempt such payments from FICA tax but the court in Quality Stores applied the standards set forth in section 3402(o) to exempt SUB pay from FICA taxes.

 
Note that section 3402(o) has three requirements:
1. amounts are paid to an employee pursuant to a plan
2. as a result of an involuntary separation from employment
3. related directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions.

We expect that many companies will be able to meet these requirements as a result of their recent severance payments.

We expect that the Service will likely appeal this case. However, because the statute of limitations expires three years after such amounts are reported (for example, April 15, 2010, for the 2006 calendar year) we are recommending that employers file protective refund claims to prevent loss of benefits due to the statute running. Companies should quantify the potential refunds and should file such a claim if such amounts are meaningful.

To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this
communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding taxrelated
penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or
recommending to another party any tax-related matters addressed herein.
Material discussed in this tax alert is meant to provide general information and should not be acted on without professional advice tailored
to your firm's individual needs.

CONTACT:
ANDREW GIBSON
404-979-7106
agibson@bdo.com
JAMES
BLINKA
414-287-1118
jblinka@bdo.com
PETER KLINGER
415-490-3214
pklinger@bdo.com
JOAN
VINES
214-259-1414
jvines@bdo.com
DERRICK NEUHAUSER
312-616-4664
dneuhauser@bdo.com
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