In a recent federal district court tax case in Michigan, an employer succeeded in treating severance pay as exempt from FICA tax. This has prompted other employers across the country to consider filing refund claims in appropriate cases for FICA tax paid on severance payments to employees terminated within the last 36 months. It is not known at this time whether the IRS will pay those refund claims so the amount of time and effort expended in filing such protective claims should be carefully measured.
In the case, Quality Stores, Inc. v. U.S.
, 2010 U.S. Dist. LEXIS 15825, February 23, 2010, the court held that in order for severance payments to be exempt from FICA tax, it must meet these requirements:
- Paid to employees pursuant to a “plan” sponsored by the employer;
- Paid because of the employee’s involuntary separation from employment (whether temporary or permanent); and
- The direct result of a reduction in force, the discontinuance of a segment of business operations, etc.
To obtain a refund of FICA taxes paid, an employer must file IRS Form 941-X for the quarter in which the payments were made. The 941-X must be filed within 36 months of the due date of the original 941, e.g., the statute of limitations on the quarter ended September 30, 2007 runs out on October 31, 2010.
The explanation area of Form 941-X, Line 21, should be completed stating that FICA taxes under IRC § 3121 were withheld and paid on these severance payments and that under the Quality Stores, Inc. v. U.S.
case, the U.S. District Court for Western Michigan ruled that severance payments that meet the requirements of IRC § 3402, stated above as 1-3, are not wages for FICA purposes, and therefore, not subject to tax under IRC § 3121. State that you meet each of the three tests listed above.
One hurdle in dealing with a FICA tax refund claim is the employee’s right to a matching refund. The IRS expects employers to contact the affected employees to try to obtain either a consent from the employee for the IRS to collect the employee’s share of the refund to be passed on to the employee or to pay the employee his share in advance or simply apply only for the employer’s portion. Since the odds on getting a refund in this case are highly speculative, few employers will want to advance any refund to the employee. The instructions to Form 941 prescribe the language of the consent form which can be used and the consents should not be attached to the 941-X but kept in file. If a refund is obtained, amended W-2 forms for the year must be issued.
Be sure to keep a copy and mail the 941-X to the IRS by certified mail. If you have questions, feel free to contact us.