On September 7, 2012, the Sixth Circuit of Appeals (which encompasses Michigan, Kentucky, Ohio and Tennessee) held in United States v. Quality Stores, Inc. that severance payments to former employees pursuant to an involuntary reduction in work force are not taxable “wages” for purposes of Medicare and Social Security withholding under the Federal Insurance Contributions Act (“FICA”).^[1] This affirmed the earlier decision by the Western District Court of Michigan. ^[2]

Quality Stores was a retailer for farmers and gardeners. In 2001, Quality Stores was forced to close its distribution centers and stores due to its filing bankruptcy. The company offered two different severance plans to employees. Under both plans, each employee received severance pay in accord with his/her years worked and status.

This severance pay was classified by Quality Stores as gross income for tax purposes. Thus, the payments appeared on W-2 forms as “wages.” In addition, Quality Stores withheld federal income tax, paid the employer FICA tax, and withheld the employees’ share of FICA tax. Quality Stores then remitted the FICA taxes. Though it believed severance pay was considered “wages” for withholding purposes, Quality Stores disagreed with the IRS as to whether the severance payments constituted “wages” under FICA – Quality Stores believed it should be considered supplemental unemployment compensation benefits (“SUB pay”) for FICA purposes.

This is not the first time such an issue has been presented to the Court. The Federal Circuit reached the opposite decision in 2008—concluding that SUB pay should be treated as “wages” for FICA purposes.^[3] The split in the federal circuits signals that continuing litigation is likely. The U.S. Court of Appeals for the Sixth Circuit denied the government’s petition for rehearing en banc in Quality Stores on January 4, 2013. The government has until April 4, 2013 to file for certiorari in the Supreme Court. If the government seeks Supreme Court review, it may be months before the Supreme Court accepts or denies to hear the case, and the issuance of a final resolution could take years. According to the IRS, there are billions of dollars at stake on this issue.

What does this mean for you as an employer? Quality Stores presents an opportunity for employers in Sixth Circuit states to file FICA tax refund claims for the open years for FICA taxes paid and withheld on SUB pay.  Affected employers should act now to protect themselves from the statute of limitations by filing refund claims for all open years. The deadline for filing a protective claim with respect to FICA taxes paid in 2009 is April 15, 2013. Unless the Supreme Court reverses the ruling in Quality Stores, the IRS will be required to start processing refunds for the 6th Circuit taxpayers.

_{[1] 693 F.3d 605 (6th Cir. 2012)}

_{[2] 424 B.R. 237 (W.D. Mich. 2010)}

_{[3] CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008)}