Written Any Severance Checks Lately? You May Be Entitled to a Tax Refund

Employers in Kentucky, Michigan, Ohio, and Tennessee who have withheld FICA tax on severance payments made in connection with layoffs or plant closings might be getting some money back from the IRS. Law firm McDermott Will & Emery:

“The U.S. Court of Appeals for the Sixth Circuit recently held that certain dismissal payments were Supplemental Unemployment Compensation Benefits (SUB) exempt from FICA taxes … For employers that have made significant reductions in force payments in open years, the Quality Stores decision could lead to significant refunds of FICA tax.”

The ruling only applies to employers in the Sixth Circuit. But because it conflicts directly with a recent Federal Circuit appeals court decision that narrowed the criteria for FICA-exempt payments, further rulemaking is likely. William Hays Weissman and Aurelio Pérez (from law firm Littler) explain:

“Given the clear circuit split, the potential cost to the Treasury, and the implications of continued uncertainty for any business that has provided or plans to provide a SUB payment such as severance pay to any former employee, it seems almost certain that this decision will be appealed to the Supreme Court. Alternatively, the IRS could prospectively resolve the problem by promulgating [additional] regulations … or Congress could more clearly define SUB pay by amending the Internal Revenue Code.”

Until then, three takeaways from the ruling:

1. The ruling rejects IRS traditional limits on the types of payments that are exempt:

“According to the IRS, FICA-exempt SUB payments must be made on account of layoff, plant closure or similar event; must be paid in installments; and must be paid only to individuals eligible for state unemployment compensation benefits. Only the first of those criteria was required by the Court of Appeals.” (Leonard, Street and Deinard)

2. Employers should continue to withhold FICA taxes:

“In light of the current uncertainty, and given the likelihood that the IRS will issue assessments to employers that decline to withhold and remit FICA taxes on severance payments, we recommend that employers continue to withhold FICA on severance payments that fall within the definition of IRC section 3402(o)(2)…” (Littler)

3. Sixth circuit employers should act now to protect future refunds:

“Although filing a complete refund claim can be burdensome from an administrative perspective, it is relatively easy for an employer to file a protective claim to preserve the statute of limitations on employment tax refund claims for open years and later file a supplementary claim with necessary employee consents and exact calculations.” (McDermott Will & Emery)

The updates:

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