FICA SUB Pay – Supreme Court Case Underway- Jan 2014 Update

After years and years of waiting, the final resolution of the SUB-Pay tax treatment issue is finally underway.  Today, the Supreme Court will take oral arguments from the Obama administration and Quality Stores regarding the seemingly confusing and contradictory language in the IRS tax code related to FICA taxes and severence pay.

Based upon the opinion of many legal experts, the tax code surrounding the treatment of serverance is quite gray and subject to interpretation.  Likewise, there is no consensus regarding the expected final outcome of the case.  It is expected that a decision will be reached and decided towards end June 2014.

Next Steps for Employers

First, as detailed further below, employers that may have had material severance pay in 2010, should strongly consider filing a Protective Refund filing for the 2010 period prior to April 15, 2014.  This will help retain your rights to potential refund recovery if the case goes in favor of Quality Stores.

Additionally, if you previously filed for Protective Refunds for years prior to 2010 which subsequently received of a Notice of Claim Disallowance, you should track the timelines from date received to see if any of these Disallowance letters are approaching 2 years.  If yes, you may then consider filing Form 907 (Agreeement to Extend Time to Bring Suit) to help maintain rights to protective refund claim without having to bring suit.

Background on Quality Stores

At issue in Quality Stores is whether SUB payments made to former employees are wages subject to social security and Medicare (FICA) tax. The Sixth Circuit Court agreed with Quality Stores that they are not wages. This decision means that this single company and its former employees are entitled to a refund of over $1 million dollars total FICA taxes paid on SUB payments.

There is an estimated $2 billion dollars at stake when all eligible FICA SUB Pay refund claims are considered.

A related case, CSX Corp., was heard in the Federal Circuit and decided in favor of the IRS, with the court finding that SUB pay is subject to FICA. The different outcomes hinge in part on competing definitions of what constitutes SUB pay: “statutory” and “administrative.”

The statutory definition was adopted by the court in Quality Stores. It’s straightforward and taxpayer-friendly. Taken from IRC Sec. 3402(o)(2)(A)), it has 5 components:

1. Amounts paid to employee
2. Pursuant to employer plan
3. Employee’s involuntary separation
4. Due to reduction in workforce or closure
5. Included in employee’s gross income

The administrative definition was adopted by the court in CSX Corp. Derived from a series of IRS revenue rulings, it’s complex and limiting:

  • – Complex 8-factor test with changing definitions
  • – Must not be a made as a lump sum payment
  • Payment must be tied to receipt of State Unemployment Compensation

Because of the different decisions: pro-IRS in CSX. Corp. (Federal Circuit) and pro-taxpayer in Quality Stores (Sixth Circuit) there is now a split between the circuits that must be resolved.

What Does This Mean for Taxpayers?

Employers should strongly consider to move forward with protective filing claims for any periods in which they incurred significant cost for FICA on SUB pay (example: in Q4, 2010 you had to close a location). Even if you are located outside of the Sixth District, if you have a significant amount of money at stake, you should take steps to preserve your right to refund in the event this is ultimately decided in the taxpayers favor. If you do nothing but wait, your rights will expire and you will forfeit your claim to a refund.

In the meantime, you must continue to withhold FICA on SUB pay. You may try to plan future reductions in force with the definitions of SUB pay in mind (it may be possible for you to meet the more stringent IRS’ administrative definition of SUB pay and save yourself money and trouble). Also, stay on top of all deadlines, track all communications, and retain all necessary data (beware of automatically destroying data for former employees who received SUB pay).

Further Reading:

  • ETS Guidance on Filing Protective Claims
  • Protective Filings on FICA Refunds for SUB Pay

Download ETS’ Presentation on FICA SUB Pay: