Protective Claims Decision for Employers on Quality Stores/ FICA

The Supreme Court has finally issued a ruling on the Quality Stores / FICA severance pay taxability issue that has been winding its way through the various courts based on circumstances that now reach back over a decade (Quality Stores filed bankruptcy in 2001 and the issue stems from related layoffs of approximately 4,000 employees).

This case has had as many twists and turns as a telenovela, providing great drama and suspense for those of us who follow employment tax matters (see ETS’ full blog coverage of Quality Stores here). It is now, however, definitely and finally at its end. Yesterday’s Supreme Court decision overturned the Sixth Circuit Court of Appeals decision (which had ruled in favor of Quality Stores), and was unanimous (8 to 0) against Quality Stores.

Crux of the Issue

It is the opinion of all Supreme Court justices hearing the case (Justice Kagan sat out) that severance payments are defined as wages rather than supplemental unemployment compensation, and fall under the broad scope of “all remuneration for employment” as defined by FICA. View the full court decision here.

The Winners?

The IRS and the Obama Administration. They avoid paying out $1 Million for Quality Stores, and additional related employer/employee claims which could potentially have totaled over a Billion dollars.

The Losers?

Employers and employees, many of whom have filed protective claims and gone to great lengths to keep their claims valid and active throughout the duration of the case.  (See Reutersand WSJ.com‘s coverage).

Why Did the Court Rule This Way?

For one thing, the Quality Stores decision in the 6th District always conflicted with IRS interpretation and with case precedent from CSX Corp. (a parallel case that was overturned in 2008). For another, a different ruling would have conflicted with Rowan Cos. Inc., SCt, 81-1 ustc ¶9479 which states that FICA rules and income tax withholding rules should be congruent. For more detailed legal analysis, see here and here.

What Does This Mean for Employers in the 6th District (Michigan, Kentucky, Ohio, & Tennessee)?

In 2013, the IRS suspended refund claims for FICA taxes in the Sixth Circuit until the issue was decided by the Supreme Court. The IRS will now deny all of those claims on the basis of the Supreme Court decision on Quality Stores.

What Does This Mean for Employers with Protective Claims from Other Districts?

Protective claims that have been on hold and pending will now recieve final IRS rejection &/or will naturally expire once they reach statute.

What Does This Mean for Employers in General?

There is no practical change for employers because all employers have already been required to treat severance pay as subject to FICA tax throughout the duration of the case. Had Quality Stores been decided differently, the IRS would have had to issue refunds.

This is Kind of a Bummer. What’s the Upside?

There are two “sort of” positives. One, it’s been an interesting ride and it’s important that employers do fully explore their options and rights to not be taxed beyond the letter of the law. The law was ambiguous, and now its been cleared up. Sometimes the outcome is different (remember the recent decision on medical resident FICA refund claims). With so much money at stake, employers can hardly afford to not pursue potential refunds and relief.

The second positive is a reminder (per Forbes) that employers do still have an option to avoid FICA tax on severance pay. It is not often used because it’s difficult to orchestrate (it involves funding a trust account), but it is possible to structure severance payments in a way that employees can get weekly payments in concert with the receipt of their state unemployment benefits and thus not have the income counted as wages.

Download ETS’ four page reference on the latest legal compliance standards for your unemployment claims management.

Disclaimer: This article is general in nature and is not intended to replace the guidance of an employment tax expert and/or legal professional with regards to an appropriate course of action in your particular circumstances. Please consult with a professional for appropriate advice in your case. Pursuant to IRS “Circular 230” rules, any information included herewithin is not intended or written to be used for the purpose of avoiding penalties under the federal Internal Revenue Code.