Recently, the Sixth Circuit Court of Appeals ruled that certain severance payments (known as Supplemental Unemployment Compensation Benefits or “SUB Payments”) made by employers to laid-off employees are not subject to FICA taxes. Because many employers and employees have been paying FICA taxes on SUB payments, this recent court decision could provide an opportunity for your business to recoup past FICA taxes paid and reduce future tax bills.

What are FICA taxes?

The purpose of Federal Insurance Contributions Act (FICA) taxes is to fund the Social Security and Medicare programs. For 2012, 10.4 percent of an employee’s wages up to an annual limit ($110,100 for 2012) must be paid into Social Security, and an additional 2.9 percent must be paid into Medicare. Employers and employees each pay half of the imposed tax, although for 2012, the employee’s share of Social Security is 4.2 percent, while the employer’s share is 6.2 percent. The employee’s share of the FICA tax is paid by the employer by withholding the FICA tax payment from the employee’s paycheck.

On which payments are FICA taxes imposed?

To answer this question simply – FICA taxes are imposed on “wages” paid to an employee. In most cases, the term “wages” has the same meaning for both income tax withholding and FICA tax purposes. Generally, wages are defined as all forms of payment for purposes of employment. For purposes of this definition, “employment” means any service performed by an employee for the person employing him.

It may be fairly obvious that an employee’s hourly pay constitutes “wages” paid for purposes of “employment,” and thus are subject to FICA taxes. But there are many other forms of payments made from an employer to an employee that fall within the definition of “wages” for purposes of FICA.

Are severance payments subject to FICA taxes?

In the recently decided case, U.S. v. Quality Stores, the Sixth Circuit Court of Appeals ruled that FICA taxes are not to be imposed on severance payments made to employees who have been laid off, as long as certain conditions are met.

Rather than being treated as “wages,” which are subject to FICA taxes, the Sixth Circuit declared that certain severance payments classified as “supplemental unemployment compensation benefits” (SUBs) were not “wages,” and were thus exempt from FICA taxes for both the employee and employer. In order for a severance payment to be classified as a SUB payment that is exempt from FICA, it must be:

a) Paid to an employee;

b) Pursuant to an employer’s plan (rather than connected to the receipt of state unemployment compensation);

c) Because of an employee’s involuntary separation from employment, whether temporary or permanent;

d) Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and

e) Included in the employee’s gross income.

What does this mean for employers?

The Sixth Circuit’s recent decision gives companies which made these qualified severance payments, and the discharged employees who received them, an opportunity to claim refunds on FICA taxes paid on account of these payments. Employers and employees should also be able to avoid paying FICA taxes on such severance payments made in the future.

However, before taking advantage of the Sixth Circuit’s decision, you should note that this severance payment exemption is construed very narrowly. Severance payments can only escape the broad reach of the taxable FICA wage base if they are being paid so as to constitute SUB payments (e.g., due to involuntary layoffs by a company). Also, be aware that a 2008 decision out of the Federal Circuit Court of Appeals reached the opposite conclusion on whether the FICA tax applies to severance payments. Due to these conflicting decisions, the Internal Revenue Service may appeal the Sixth Circuit’s decision to the Supreme Court.

But until the Supreme Court ultimately rules on the issue, companies (outside the Federal Circuit) that have experienced recent layoffs and have paid FICA taxes on severance payments should look to use this taxpayer-friendly decision to apply for FICA tax refunds and to reduce their future FICA tax expenditures.

If you have questions about how this recent decision may impact you or your business, please contact a member of our Tax and Finance Practice Group.

Greg and Polly are two of the finalists within the Law Category who were chosen by a committee of local business leaders. They, along with the other eight finalists, will be judged on their professional accomplishments and leadership qualities to determine the Best and Brightest Award winner within the category. They will be honored at an awards event to be held at the Farm Bureau building at the Indiana State Fairgrounds on Oct. 11, 2012. Bingham Greenebaum Doll LLP was the only firm to be honored with multiple finalists in the Law category.

For more information on this year’s Best and Brightest Awards, click here.

Christi Anderson speaks on Inside Indiana Business with Gerry Dick

The Best of Bingham is a series of posts by the Bingham Greenebaum Doll LLP Women’s Forum recognizing the professional and community successes of our members, our colleagues and our clients.

An excerpt of the article is below. Click here to see the full article in The Kentucky CPA Journal.

Excerpt from “Human resources state tax issues”

Ensuring compliance with employment-related state tax laws is one of many important things that human resource (HR) professionals do.

It is common for businesses to have people who work somewhere other than where they live and work at multiple locations, often in multiple and different states and localities. Consequently, HR-type state tax issues come up from time to time – if not daily.

Click here for the full article in The Kentucky CPA Journal (Issue 4 2012).

Services may/will be performed by others.

Formaldehyde is a carcinogen, and it has been linked to cancer along with other commonly used chemicals such as 1,4-dioxane. Johnson & Johnson is the first major personal care company to make such broad sweeping changes in ingredients. Johnson & Johnson previously pledged to remove potentially harmful chemicals from its baby products by the end of 2013, but this recent announcement extends to adult products.

Johnson & Johnson maintains that its products are currently safe by scientific standards or meet or exceed government regulations. Manufacturers of consumer products will want to watch this story closely to see if Johnson & Johnson can appease consumers and avoid litigation.

An excerpt from the article is below. Click here to see the August 2012 IPT Tax Report (Article begins on page 6).

Excerpt from “Kentucky Tax Board: Captive Toller Ignored for Purposes of Energy Tax Calculation of Parent”

In Ohio Valley Aluminum Co., LLC v. Dep’t of Revenue, the Kentucky Board of Tax Appeals upheld the Kentucky Department of Revenue’s denial of a refund request for an exemption from Kentucky Sales and Use Tax and Utility Gross Receipts License Tax paid on the cost of energy used in its tolling operations. The Board determined that the manufacturer and its subsidiaries constituted “one plant” under the meaning of the exemption statute and held that the Taxpayer could not allocate the cost of raw materials to its subsidiary for purposes of the exemption.  

Click here to view the full IPT August 2012 Tax Report

The article details the statute and its 2005 amendment, noting that the amendment’s alterations to the definition of a “recreational user” arguably drastically extend the statute’s grant of immunity in circumstances where an entrance fee is paid.  Such an extension would expressly overrule decades of established Ohio jurisprudence, leading Hayden and Dressman to call for greater clarification of the amendment’s effect.

An excerpt of the article is below. Click here to see the Summer 2012 OBA Litigation Newsletter (article begins on Page 5). 

Excerpt from “Enter at your own risk: How much immunity does Ohio’s Recreational User Statute confer?”

While the amended statute’s language still states that a “recreational user” is someone who has not paid a “fee or consideration,” the new language carves out an exception when a “lease payment or fee” is paid.  The scope and meaning of this new exception is open to debate.  One interpretation is that the 2005 amendment merely sought to afford protection to defendant land owners who had received lease payments or lease fees from injured recreational visitors.  A contrary interpretation is that the statute now applies if any type of fee was paid by an injured recreational visitor.

Click here for the Ohio Bar Association Summer 2012 Litigation Newsletter

Bingham Greenebaum Doll LLP is committed to the communities it serves and is always proud to sponsor and participate in this dynamic event, which includes the AT&T Black Business Conference. The conference provides opportunities for Hoosier business leaders to gather and learn about tools and resources available to them in the competitive marketplace. This year, our firm continued its tradition of bringing educational resources directly to attendees through this conference.

Specifically recognizing the needs of small and emerging businesses, several Bingham Greenebaum Doll LLP attorneys presented a workshop titled “Legal Issues for Small and Emerging Business III: From Startup to Success to Succession.” Attorneys Greg Duncan, Rod Morgan, Cedric D’Hue, Kevin Dawson, Katherine Erdel and Tamara McMillian led the panel discussion, which included information on intellectual property issues; business organization; MBE/WBE certification; contracts and subcontracting; labor and employment; litigation; and succession planning.

The Minority and Women’s Business Enterprises 2012 Central Indiana Resource Fair also afforded Bingham Greenebaum Doll LLP the opportunity offer useful resources attendees. The theme of the fair was “Positioning Your Business for Growth.” Attorneys Rod Morgan, Kevin Dawson and Tamara McMillian represented the firm at an exhibit geared toward minority and women business owners.

A well-deserved thank you goes to those who joined us at these events – we appreciated your time and the opportunity to meet you. If we missed you this year at the Indiana Black Expo and have questions about any of the above topics, we would encourage you to contact a member of our Diversified Business Solutions team or our Services for Emerging Businesses team.