Eight years ago, the Court of Federal Claims held that held that some types of severance pay were exempt from Social Security taxation under the Federal Insurance Contributions Act (FICA). The exemption applied if the requirements in section 3402(o) of the Internal Revenue Code were met: (i) the employer had a plan; (ii) the plan covered involuntary separation; and (iii) there was a reduction in force, plant closing, or other event resulting in severance payments. CSX Corporation v. United States, 52 Fed. Cl. 208 (2002).
The court's decision was contrary to prior IRS guidance that recognized a FICA exclusion only if the payments were designed to supplement state unemployment benefits—generally meaning that the payments were made in installments and were conditioned on the individual's ongoing eligibility for state unemployment benefits. Following the CSX decision, many employers filed protective refund claims, only to be disappointed in 2008 when the decision was overturned by the Federal Circuit. CSX Corporation v. United States, 518 F.3d 1328 (Fed. Cir. 2008).
A court in Michigan has now considered the same issue and has entered a decision upholding the taxpayer's position that severance plan payments made in connection with an involuntary reduction in force were not "wages" under FICA. United States v. Quality Stores, Inc., 2010 U.S. Dist. LEXIS 15825 (W.D. Mich. Feb. 23, 2010). The court explicitly rejected the Federal Circuit's CSX holding and awarded refunds of FICA tax.
Employers who have made involuntary termination severance payments pursuant to a plan should consider filing protective refund claims. Time is of the essence for refunds of FICA taxes paid in 2006 because, in general, such claims must be filed no later than April 15, 2010.
It should be noted, however, that the decision to file a claim may not be as clear cut as it was following the CSX trial court decision.
Had CSX prevailed on appeal, the decision would have been effective nationwide. In contrast, Quality Stores is a Michigan decision that the IRS will undoubtedly appeal to the Sixth Circuit. The Sixth Circuit's decision will be binding only within that circuit (i.e., Kentucky, Ohio, Michigan, and Tennessee). We would expect the IRS to oppose FICA tax refunds elsewhere even if it loses on appeal in Quality Stores. Eventually, the issue may reach the United States Supreme Court whose decision would, of course, be binding across the country.