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Potential Refund Available for FICA and FUTA taxes on Severance Payments

A recent Western Michigan district court case determined that certain severance payments are NOT “wages” for FICA (Social Security/Medicare) and FUTA (Federal Unemployment Tax). This case breathes new life into the matter even after the IRS won a victory in an earlier Circuit Court case. The significance of this case is that the lower-level district court specifically believed that the higher-level Circuit Court made an error in its judgment. With the severe economic downturn, many taxpayers paid large amounts of severance payments in 2008 and 2009.

The taxpayer (Quality Food, Inc.) had made severance payments to its employees as a result of facility closings and workforce downsizing. These payments were originally included as subject to FICA taxes (for both the employee and employer). The taxpayer then went into bankruptcy and claimed a refund from the US Government in bankruptcy court. The bankruptcy court agreed and the case was moved to district court where the IRS lost again!

The IRS maintains that Section 3402(o) defines severance pay as wages. While we will agree that this Section does define severance pay as wages, it was the bankruptcy and district courts' opinion that it was ONLY for the purpose of federal withholding and not other taxes (FICA or FUTA). As a matter of fact, the Senate committee report regarding the enactment of Section 3402(o) specifically stated that such payments were previously not subject to withholding because they were NOT wages for services rendered. The intention was to make sure that federal withholding was taken out of these supplemental payments since they were still taxable income. However, there was no comment regarding whether these payments are subject to FICA and FUTA. Of course, the problem is that the Circuit Court decided that the inference was that supplemental unemployment benefits are subject to FICA and FUTA (i.e., it was the intention of Congress to have such payments taxed for withholding, FICA, and FUTA).

In the meantime, what is a taxpayer to do? The IRS has already stated that they will NOT follow the district court case and will not honor any claims for refund of FICA and FUTA taxes from severance payments. The IRS also announced that they will appeal the district court case. Unfortunately, a lot of time can pass before an appeal is filed, much less a decision made.

The statute of limitations runs three years after the filing of a return. Therefore, even if the IRS eventually loses its appeal, no refund claim can be made for erroneously paid taxes if the statute of limitations has passed. One way around this is to file a “protective claim.” We can assist you with the proper filing of these claims. The refund claim must be filed with the appropriate IRS center with the supporting facts and signed under penalties of perjury. Employers should confirm with their claims that it is their intent to comply with the repaying of the employee portion of the FICA refund. For severance payments made in 2007, the statute of limitation is rapidly approaching.

If you need assistance with your claims for refund, please contact Kim Haumann at 312-980-3249, or your Blackman Kallick representative.

 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.