Print this page

FICA Taxes on Severance Pay

During these troubling economic times, has your company made significant severance payments to terminated employees? If so, your company and the terminated employees may be entitled to refunds for the FICA taxes paid and withheld on the severance payments based on a recent court case.

In the United States of America v. Quality Stores case, the Sixth Circuit Court of Appeals ruled that severance payments that qualify as "supplemental unemployment compensation" (SUB payments) are excluded from the Internal Revenue Code's statutory definition of "wages." The Sixth Court stated that Congress had defined a SUB payment as:

1. An amount paid to an employee
2. Pursuant to an employer's plan
3. Because of an employee's involuntary separation from employment, whether temporary or permanent
4. Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions
5. Included in the employee's gross income

The payments made by Quality Stores satisfied all parts of the SUB payments test, and the payments did not qualify as wages. Therefore, the severance payments are not subject to FICA employment tax.

The IRS does not agree with the findings in the Quality Stores case and has filed a petition requesting the Sixth Circuit to rehear the case. Currently, no date has been set for the rehearing.  This case could ultimately go to the Supreme Court for final resolution.   This process may take several years.  In the meantime statutes of limitation are closing on payroll tax returns which will prevent taxpayers from filing amended returns to claim potential refunds. 

The statute of limitation period for filing amended returns is normally three years from the original return due date.  However, for timely filed quarterly Forms 941, the statute closes on April 15th of the following year for all four quarters.  In order to preserve your right to claim a refund if this case is resolved favorably for the taxpayer, we recommend you file a protective claim on an amended return to keep the statute of limitations open.  The IRS will not act on the protective claim until the case is resolved.  If the case is resolved in favor of the taxpayer, the IRS will refund the FICA taxes paid and withheld on the severance payments.  If the case is resolved in favor of the IRS, the IRS will not act on the protective claim and the statute will close.  

The protective claim for FICA taxes can by made by filing a Form 941X (an amended Form 941) for each quarter that included severance payments.  Employers should write at the top of the Form 941X "Protective Claim Filed Pursuant to U.S. v. Quality Stores."  A Form 8275 should also be attached to each Form 941X.  Employers that made severance payments during 2009 should act immediately on filing protective claims for 2009 since the deadline is April 15, 2013 if all four of their 2009 quarterly returns were timely filed.

As the law stands today, we recommend that employers continue to pay and withhold FICA taxes associated with any severance payments. In addition, employers should file a Form 941X protective claim, along with Form 8275, to request a refund of the FICA tax paid and withheld on severance payments particularly for 2009 severance payments since that deadline is fast approaching.

For more information, contact HORNE Tax Partner John D. Scott, CPA, at john.scott@horne-llp.com or Tax Services Director Maureen Scott, CPA at maureen.scott@horne-llp.com.