By James A. Nitsche
The Supreme Court has announced that it will review a decision of the Sixth Circuit Court of Appeals that payments made by a company to employees pursuant to a severance plan were not “wages” subject to Federal Insurance Contribution Act (“FICA”) taxes.
In the Sixth Circuit case, In Re Quality Stores, Inc., 693 F2d 605 (6th Cir. 2012), an employer made severance payments to employees whose employment was terminated involuntarily when the employer closed its stores and discontinued business. The employer withheld income and FICA taxes from payments made to the terminated employees, and paid the employer’s share of FICA taxes with respect to such payments, but subsequently filed claims requesting refunds of all such FICA taxes. When the IRS denied the refund claims, the employer filed a suit for refund as part of a bankruptcy proceeding. The bankruptcy court ordered a full refund, holding that the payments made by the employer to its terminated employees constituted supplemental unemployment compensation benefits that are not treated as wages for FICA tax purposes. The Sixth Circuit affirmed the bankruptcy court’s decision.
The Quality Stores decision hinged on the courts’ analysis of the relationship between the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), that require withholding of income and FICA taxes on “wages” paid to employees. In general, Code Section 3402(a) requires an employer to withhold income taxes on “wages,” as defined by Code Section 3401(a), paid to employees. Meanwhile, Code Section 3102(a) requires that FICA taxes be withheld from “wages,” as defined by Code Section 3121(a), paid to employees. While the definition of wages under Code Section 3401(a) may be substantially similar to the definition of wages under Code Section 3121(a), the two are not identical. Nevertheless, in Rowan Cos. v. United States, 452 U.S. 247 (1981), the Supreme Court examined the language and legislative history of Code Sections 3401(a) and 3121(a) to conclude that Congress intended the term “ wages” to carry the same meaning for purposes of income tax and FICA tax withholding.
In Quality Stores, the IRS asserted that Congress legislatively superseded Rowan when it enacted a “decoupling amendment” as part of the Social Security Amendments of 1983. In response, the Sixth Circuit noted that, while the legislative history of that amendment reveals Congress’ intent that the income tax withholding and FICA tax withholding provisions of the Code be interpreted independently, Congress has never amended the Code to make that clear. Hence, the Sixth Circuit concluded, Rowan remains good law.
Having reached that conclusion, the Sixth Circuit had little difficulty in determining that the payments in issue were not “wages” for FICA tax purposes. It did so on the basis of the language of the Code Section 3402(o). That statute, which was enacted in 1969, bears the title “Extension of withholding to certain payments other than wages.” Based on the statute’s title and Rowan, the court concluded that payments described in Code Section 3402(o) are not wages for either income tax withholding or FICA tax withholding purposes.
Among the payments identified as “nonwages” by Code Section 3402(o) are any supplemental unemployment compensation benefits paid to an individual (“SUB payments”). See Code Section 3402(o)(1)(A). According to Code Section 3402(o)(2)(A), SUB payments are amounts paid to an employee, pursuant to a plan of which the employer is a party, because of an employee’s involuntary separation from employment, resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions.
The decision in Quality Stores stands in contrast to that rendered by the Court of Appeals for the Federal Circuit in CSX Corporation, Inc. v. United States, 518 F.3d 1328 (Fed. Cir. 2008). In CSX, the employer, a railroad company, was experiencing financial difficulties that compelled it to reduce its workforce substantially. The case involved a variety of payments the employer made to employees who lost their jobs as a result of the workforce reduction. The appeals court agreed that at least some of the payments qualified as SUB payments described in Code Section 3402(o)(a)(A). Unlike the Sixth Circuit in Quality Stores, however, it rejected the notion that if a particular payment is not wages for income tax withholding, it must not be wages for FICA tax purposes. In reversing the trial court and holding that all the payments in issue were wages for FICA tax purposes, the court acknowledged that the case involved a “complex” issue of statutory construction whose correct resolution is “far from obvious.” id. at 1340. In reaching its decision, the court noted that, by its express terms, Code Section 3402(o)(1) applies only for purposes of Chapter 24 of the Code, which deals exclusively with income tax withholding. id. at 1341. “Congress’ decision to restrict the scope of the rule set forth in Section 3402(o) to Chapter 24 suggests that Congress did not intend that rule, or any implication that might be drawn from that rule, to be applied outside the context of income tax withholding.” id. The Sixth Circuit made no mention of this limiting language in its Quality Stores opinion.
Given the complexity of the issue, it is difficult to predict how the Supreme Court will decide the issue. Until then, employers are advised to proceed with caution regarding the proper FICA tax treatment of any SUB payments they make. In addition, it must be emphasized that the Quality Stores decision is limited to the FICA tax treatment of SUB payments, and has no bearing on typical severance payments made by employers to employees in the normal course of business, which ordinarily are considered “wages” for all income and employment tax withholding purposes.