Text of the 21-page decision: Quality Stores, Inc. [PDF 60 KB]
Read a July 2010 report [PDF 101 KB] on the lower courts’ decision: KPMG’s What’s News in Tax: Quality Stores Renews Hope for Potential FICA Tax Refunds
Today’s decision is contrary to the Federal Circuit’s decision in CSX Corp. v. United States which characterized supplemental unemployment compensation benefits (SUB payments) as “dismissal pay” subject to FICA tax.
This case was an appeal that originated from an adversary action filed in federal bankruptcy court.
Prior to bankruptcy, approximately 75 employees were laid off. After filing a Chapter 11 petition, all remaining employees were terminated. Severance payments were made to employees pursuant to the company’s severance plan when the workers were involuntarily dismissed as a result of a reduction in force or the discontinuance of a plant or operation. The severance payments were reported as wages on Forms W-2 issued to the employees.
The company withheld federal income tax and FICA taxes from the severance payments.
In bankruptcy, the company sought a refund of approximately $1 million for the FICA taxes paid with regard to the severance payments. The bankruptcy court ordered a full refund, holding that payments made to the employees upon terminating their employment involuntarily, due to business cessation, constituted SUB payments that are not taxable as wages under FICA.
The federal district court affirmed the decision of the bankruptcy court.
Today, the Sixth Circuit affirmed, and concluded that the payments made to the employees qualified as SUB payments under section 3402(o) and, therefore, are not subject to FICA tax (although the payments are still a treated as income to the employee).
As the Sixth Circuit noted, because Congress provided that SUB payments are not “wages” and are treated only as if they were “wages” for purposes of federal income tax withholding, such payments are not “wages” for purposes of FICA taxation.
In this case, the company paid involuntary separation payments as part of a termination of the business. The Sixth Circuit noted that:
…Congress has provided that a SUB payment is: (1) an amount paid to an employee; (2) pursuant to an employer’s plan; (3) because of an employee’s involuntary separation from employment, whether temporary or permanent; (4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee’s gross income.
It is not clear that an individual employee’s separation agreement would fall within this decision.