Back in 2010, we did a brief write-up in the Employment Tax Reporter of the Quality Stores case and its impact on FICA refund claims related to severance payments made to involuntarily terminated employees. We are revisiting the issue as the statute of limitations for filing a refund claim for that specific class of FICA tax payments (relating to severance payments made to involuntarily terminated employees) for the 2008 calendar year should be submitted by April 15th, 2012.
We will state from the outset that the outcome of such refund claims is uncertain, and the likelihood of successful return on these claims is not great…..that being said, if your organization made significant severance payments to involuntarily terminated employees in 2008, and particularly if you have operations within the Sixth Circuit (Kentucky, Ohio, Michigan, and Tennessee) filing these protective claims is probably something worth pursuing in an effort to hedge your bets in the event the case settles in the employers’ favor.
The IRS has been denying FICA refund claims filed for the 2007 tax year and it is reasonable to expect that they will continue to do so (unless you are within the Sixth Circuit, in which case the IRS is simply not acting on claims). However, by filing the FICA protective claims you retain the right as an employer to seek recovery of potential FICA tax overpayments in a suit for refund when the claims are denied by the IRS.
There are two legal precedents for FICA taxes paid on severance payments to involuntarily terminated employees: The first is 2008’s CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir.2008), which the IRS won on the grounds that severance payments must meet the requirements of Revenue Ruling 90-72 and Revenue Ruling 56-249 in order to be considered exempt from FICA. The second is 2010’s Quality Stores Inc, et al, v. United States, 424 B.R. 237 (W.D. Mich 2010). In Quality Stores, a Michigan District Court held that severance payments did NOT have to meet the requirements of Revenue Ruling 90-72, thus ruling for a refund of FICA taxes to the taxpayer. The IRS appealed the District Court’s Quality Stores decision to the Sixth Circuit Court of Appeals, which is ongoing with oral arguments heard on October 6, 2011. (For more detail on both the Quality Stores and CSX Corp. cases, you may want to refer to the American Payroll Association's Amicus Brief filed on behalf of the Quality Stores' Appellees).
Depending on the outcome in the Sixth Circuit, if the IRS wins, other lawsuits would have to be filed against the IRS in other District Courts within the other Circuits, and then appealed by either side back to a Court of Appeals which could then hopefully be convinced to rule in favor of the employer. On the other hand, if the employer wins in the Sixth Circuit, it will result in a split in the Circuits, and the opinion would only have bearing within the Sixth Circuit (Kentucky, Ohio, Michigan, and Tennessee). It is also likely that the IRS might then petition for certiorari to the Supreme Court on account of the split Circuits, and also on account of the fiscal impact of the IRS having to pay out a large amount of FICA claims.
Based upon recent experience, it should be expected that the IRS will disallow the claim (which is unusual in light of the typical IRS policy of allowing protective claims to remain in suspense pending outcome of a contingency). If this does occur, an employer may then consider filing a protest letter contesting the disallowing to the Office of Appeals to help preserve their rights to a potential settlement.
In sum (for those of you who have NOT already filed a 2008 FICA severance protective claim), at this time you need to weigh the upfront time and resource needs to prepare the claim versus the potential refunds if the claim is finally approved and refunded.
I Might Want to File a Claim; What Else Do I Need To Know?
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Disclaimer: This article is general in nature and is not intended to replace the guidance of an employment tax expert and/or legal professional with regards to an appropriate course of action in your particular circumstances. Please consult with a professional for appropriate advice in your case. Pursuant to IRS "Circular 230" rules, any information included herewithin is not intended or written to be used for the purpose of avoiding penalties under the federal Internal Revenue Code.