In CSX Corp. Inc. v. United States, the court rejected the IRS' interpretation of what constitutes supplemental unemployment compensation benefits that are exempt from FICA. It adopted a broader standard, which could exempt many payments previously thought to be subject to these taxes.
Under the IRS code, supplemental unemployment compensation benefits are payments an employer makes to an employee due to involuntary separation of employment resulting directly from a reduction in force, the discontinuance of a plant or other similar conditions. The court held that supplemental unemployment compensation benefits as defined by that section are not wages for purposes of FICA.
Guidance from the IRS prior to this decision suggested that supplemental unemployment compensation benefits are exempt from FICA only if they are linked to the receipt of state unemployment compensation and not paid in a lump sum. Accordingly, most severance pay had been considered subject to FICA taxation, even if made on account of an employee's involuntary separation of employment.
Employers should not stop paying FICA taxes on severance pay in reliance on the CSX decision. It's unclear whether the decision will hold up on appeal or whether it will have any effect on the position taken by the IRS in audits. Until this is clarified, employers that stop paying FICA taxes on severance pay risk being assessed penalties.
Employers may wish, however, to file protective refund claims for FICA taxes paid on account of severance pay to preserve their ability to seek a refund before the statute of limitations closes.
A claim must be filed generally no later than three years from April 15 of the year following the tax year to which the taxes relate. The statute of limitations for FICA taxes paid on time for the 1999 tax year expires on April 15, 2003. Kathryn English and Holly McCann are attorneys in the Tax, Estates and Benefits Department at Eckert Seamans Cherin & Mellott LLC. Reach them at (412) 566-6000.