Federal Appeals Court Holds That Supplemental Unemployment Compensation Benefits Are Not ‘Wages’ Subject To FICA Taxation, Creating Circuit Split

Overview

In an important recent decision, United States v. Quality Stores, Inc., et al., Case No. 01-1563, 2012 U.S. App. LEXIS 18820 (6th Cir. Sept. 7, 2012), the U.S. Court of Appeals for the Sixth Circuit held that supplemental unemployment compensation benefits (SUB payments) paid by a bankrupt company to its former employees were not wages subject to taxation under the Federal Insurance Contributions Act (FICA). Accordingly, the employer and its former employees were entitled to refunds of amounts paid to the Internal Revenue Service (IRS) on account of FICA taxes from severance payments that had been made after the employer filed for bankruptcy. The Sixth Circuit declined to follow a contrary 2008 decision on the issue of the Federal Circuit, CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), the only other court of appeals decision to address the issue. The refund claim at issue in Quality Stores totals approximately $1 million (plus interest); it is estimated that similar pending refund claims total over $4 billion.

A reduction in federal tax liability is obviously beneficial to both employer and employee taxpayers. The Quality Stores decision could be especially beneficial to lower wage employees for whom FICA taxes constitute a major portion of their federal tax liability. Elimination of FICA tax liability would also increase the disposable income available to employees already suffering reduced earning prospects as a result of being laid off.

From the employer standpoint, the reduced FICA tax liability would free up money for deployment elsewhere in the enterprise at a time when funds may be tight. Employers who made severance payments to involuntarily terminated employees during the last few years could be affected by the decision. Thousands of companies are believed to have filed protective refund requests totaling $4 billion or more. Taxpayers should be aware of both a three-year statute of limitations to file a refund claim and a two-year statute of limitations for bringing a lawsuit after the denial of a refund request. It appears that many taxpayers have filed refund requests within the statute of limitations period to ensure that such requests were timely filed. It is believed that the IRS has been inundated with refund claims and, therefore, may not have processed the claims and communicated with taxpayers about the status of such claims in an orderly fashion. As a result, some taxpayers may be unaware that their refund requests have been denied because they may not have received notice of the denial. In such a case, the taxpayer may be unaware that the two-year period is running. Where lawsuits have been filed, the government reportedly has moved to stay the action pending the outcome of the Quality Stores litigation.

Quality Stores not only created a conflict among the federal courts of appeal on the applicability of FICA taxes to SUB payments, but it also raised a number...