Ivins Recommends Protective FICA Tax Refund Filings for 2006 Reductions in Force

 ** April 15 Deadline **

Prompted by the initial CSX victory in the Court of Federal Claims in 2002, many companies filed protective refund claims for the employer and employee social security and hospital insurance (“FICA”) taxes paid on severance payments for involuntary separation. Following reversal of the CSX decision by the Federal Circuit in 2008, most companies determined that the filing of additional refund claims would be unproductive.

Now there is a new district court case on this issue which offers renewed hope. In Quality Stores, the US District Court for the Western District of Michigan held that involuntary severance benefits paid in connection with a reduction in force or other downsizing event are not “wages” subject to FICA tax. The ruling affirmed a Bankruptcy Court decision which held, even after reconsideration following the Federal Circuit’s 2008 reversal in CSX, that involuntary severance pay was excluded from FICA tax. Significantly, both the bankruptcy court and district court decisions took issue with the Federal Circuit’s analysis in the CSX case. The upshot is that three of the four courts that have now looked at the issue have found in favor of a FICA tax exception for involuntary severance benefits paid in connection with a reduction in force or other downsizing. And even though the one decision against the taxpayer is a circuit court decision, the Federal Circuit admitted in its opinion in the CSX case that it had struggled with its decision when it stated that “we acknowledge that this issue of statutory construction is complex and that the correct resolution of the issue is far from obvious.”

The IRS, which took the position in Revenue Rulings 56-249 and 90-72 that severance is excluded from FICA only in narrow circumstances, is certain to appeal the Quality Stores case. But there is now the possibility of a circuit split on this issue if the Quality Stores decision is affirmed by the Sixth Circuit. As a result, we are recommending that any employer who made significant involuntary severance payments to employees in 2006 (or in 2007 through 2009) seriously consider filing protective FICA tax refund claims.  The statute of limitations is set to expire for the 2006 calendar year on April 15, 2010, so quick action is required to make a 2006 calendar year refund claim.

We have filed a number of these refund claims in the past and would be glad to assist companies in filing such protective refund claims.  Although the timing is short, such refund claims are relatively easy to file, even considering the recent changes to some of the refund tax procedures/forms. A company can file the protective refund claim by estimating the actual disputed amount of FICA taxes paid and “perfect” the claim later if requested by the IRS (i.e., by more precisely determining the amount of the disputed FICA taxes paid and collecting the employee consents necessary for it to seek a refund of the FICA taxes paid on their behalf).

NOTE:  For companies that filed refund claims for earlier years based on the CSX district court case, Quality Stores provides a basis for appealing any initial denial of the claim by the IRS – a step we recommend as a way to keep the statute of limitations open until the Sixth Circuit is able to rule in Quality Stores.