Severance pay due to an involuntary separation from employment resulting from a reduction in force, plant shutdown or similar condition may be exempt from FICA taxes. As we reported in September 2012, the U.S. Court of Appeals for the Sixth Circuit found in Quality Stores that severance pay is not required to be tied to continued eligibility for unemployment benefits in order to be exempt from FICA. (Click here for more details regarding the Quality Stores decision.) Shortly after this decision the Internal Revenue Service (IRS) requested that the Sixth Circuit reconsider its decision in an en banc review (i.e., a hearing before all judges on the circuit court). Earlier this month, the Sixth Circuit denied this request.
The Quality Stores decision creates a clear split with the U.S. Court of Appeals for the Federal Circuit. In light of the Sixth Circuit’s denial, the IRS will likely file a writ of certiorari with the Supreme Court of the United States seeking a reversal of the Quality Stores decision. For now, the IRS is refusing refund claims outside of the Sixth Circuit and taking no action with respect to refund claims within the Federal Circuit (states within the Sixth Circuit are Kentucky, Ohio, Michigan and Tennessee). For now, employers should continue withholding FICA taxes on severance pay that is not tied to unemployment benefits.
Employers that have made severance payments due to reductions in force, plant shutdowns or similar conditions should consider filing protective FICA tax refund claims. Only a limited period of time is available to file. In general, the statute of limitations for tax refund claims is three years. As a result, April 15, 2013, is the due date for taxpayers for filing a refund claim with respect to the 2009 calendar year. A refund claim cannot be filed with respect to severance payments made before 2009.
Filing a protective claim is relatively simple to do. It is not necessary that the protective claim include exact calculations and employee consents for the refund filing. This information and the required employee consents can be provided at a later time in a supplemental filing. It is recommended that all employers file protective claims, particularly with respect to severance payments made to employees located in the Sixth Circuit.
If a FICA tax refund has been filed and the IRS has issued a notice of claim disallowance, the taxpayer must either (i) bring suit to contest the disallowance within two years after the issuance of this notice or (ii) obtain an extension of the time to file such a suit with the IRS—this process can be initiated by filing IRS Form 907, Agreement to Extend the Time to Bring Suit.