In United States v. Quality Stores Inc., No. 10-1563, the Sixth Circuit Court of Appeals has held that severance pay, though gross income, was not subject to employment taxes. United States v. Quality Stores, Inc., No. 10-1563, 2012 WL 3871364, (6th Cir. Sept. 7, 2012).
Prior to filing bankruptcy, Quality Stores, the largest agricultural implement retailer in the U.S., closed all of its stores. Under the bankruptcy’s Pre- and Post- Petition Severance Plans, terminated employees were given severance pay based on their length of service. Quality reported the severance pay on its employee W-2 forms and withheld federal income tax. Quality also properly withheld the employee portion and paid their portion of the FICA tax. Because Quality believed the severance payments were SUB payments and not subject to FICA, the company filed a claim for a refund of both the employer portion and, to the extent that it had written permission from employees to file claims on their behalf, the employee paid FICA tax as well. Later Quality filed an adversary action in bankruptcy court.
The bankruptcy court agreed with Quality and ordered the IRS to refund the overpaid FICA taxes to the debtors’ bankruptcy estate. The government filed a motion for reconsideration of the bankruptcy court decision after CSX Corp. v. United States held that some SUB payments were not subject to FICA tax. CSX Corp. v. United States, 52 Fed. Cl. 208 (Fed. Cl. 2002). When the bankruptcy court ratified its previous decision, Quality appealed to the federal district court, which affirmed the bankruptcy court’s decision. Quality appealed.
According to the Sixth Circuit Court of Appeals, SUB payments are not wages subject to federal income tax withholding if they are 1) an amount paid to an employee; 2) pursuant to an employer’s plan; 3) because of an employee’s involuntary separation from employment; 4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and 5) included in the employee’s gross income. Whether an employee receives state unemployment compensation benefits or receives the severance pay in a lump sum are not requirements.
The Court of Appeals held that the severance payments were SUB payments, not subject to federal tax withholding, because Quality met all five requirements. As the Sixth Circuit’s decision conflicts with other circuit opinions, the U.S. Supreme Court may have to resolve the conflict.
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