While the underlying purpose of the FICA tax for employers and employees has remained largely unchanged throughout the years, the wages subject to this tax have recently created much debate. One area in particular that has recently received national attention is whether or not severance pay pursuant to an involuntary layoff should be held subject to FICA employment taxes.

This controversial topic has received national attention as a result of a recent decision made by the Court of Appeals for the Sixth Circuit Court which contradicted a previous decision made by the U.S. Court of Appeals for the Federal Circuit Court in 2008. In September of 2012, the Court of Appeals for the Sixth Circuit Court ruled in favor of the taxpayer concluding that severance payments constitute supplemental unemployment benefit compensation subject to income tax withholding but not FICA tax withholding under Section 3121 of the Internal Revenue Code (United States v. Quality Stores, Inc.). Whereas in 2008, the U.S. Court of Appeals for the Federal Circuit Court ruled in favor of the Internal Revenue Service deciding that severance payments were subject to both income and FICA tax withholding (CSX Corporation Inc. v. United States).

In May of 2013, the Internal Revenue Service filed a petition requesting that the U.S. Supreme Court review the Sixth Circuit Court's decision. The U.S. Supreme Court recently scheduled oral arguments for January 2014.

As a result of this recent debate, taxpayers now have an opportunity to file protective claims with the IRS until they reach a final resolution to this issue. By filing a protective claim, the taxpayer preserves the right to refund without regard to the statute of limitations, should the IRS alter its current position of rejecting these claims. While there are a number of refund claims pending, the IRS has suspended acting on them until a final decision has been made.

Taxpayers who believe they may be eligible for a refund as a result of the FICA tax on a severance payment should consider filing for this protective claim in order to preserve the potential to receive refunds for open tax years under the statute of limitations. Protective claims for 2010 must be filed by April 15, 2014.

The main determinants in figuring out whether a payment qualifies for the FICA tax exclusion are the wording in the severance agreement and the terms of the severance payment. To qualify as a severance payment, the payment must meet all of the following criteria as defined in IRC Section 3402(o)(2)(A): 

• Amounts which are paid to an employee,
• Pursuant to a plan to which the employer is a party, because of an employee's involuntary separation from employment (whether or not such separation is temporary),
• Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions, and
• Are includible in the employee's gross income. 

If you have any questions, please contact Kathy Ettensohn, CPA, CIRM at 800.880.7800 ext. 1384, kettensohn@hsccpa.com for more information. 

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