Legal Considerations of SUB-Pay Plans
Origins of Supplemental Unemployment Benefit ("SUB-Pay") Plans
Since they were first introduced by organized labor and the Department of Labor in the early 1950's, and first issued in a Revenue Ruling by the IRS in 1956, SUB-Pay Plans have enabled employers to supplement the receipt of state unemployment insurance benefits for employees that experience an involuntary layoff. By establishing severance payments as SUB-Pay benefits, the payments are not considered wages for FICA, FUTA and SUI tax purposes, and employee FICA tax. To qualify for SUB-Pay benefits, the participant must be eligible for state unemployment insurance benefits and the separation benefit must be paid on a periodic basis.
FICA Tax Protective Refund Claims vs. FICA Tax Savings
In response to a September 7, 2012 Sixth Circuit Court’s decision in the case of United States v. Quality Stores, Inc., many employers are filing “FICA tax protective refund claims” even though there is no assurance that their refunds will be approved. As of October 1, 2013 the case was agreed to be heard by the Supreme Court. On January 14, 2014 the Supreme Court heard opening arguments with a decision set for summer 2014. In the meantime many Fortune 1000 companies, and their downsized employees, are currently receiving an immediate and guaranteed FICA tax savings by modifying their severance plan to a SUB-Pay Plan.
Since 2002, District, Federal Circuit and US Appeals Courts have been considering whether severance pay is considered wages for FICA tax purposes. As this case proceeds through the courts, employers have filed for more than $1 billion in protective refund claims for FICA taxes paid on severance payments.
CSX Corp. v. United States
During 1984 to 1990, CSX reduced its workforce significantly and paid the employer’s share of FICA taxes on the severance payments. CSX filed claims for a FICA tax refund on the basis that severance is SUB-Pay as defined by an Internal Revenue Code for income tax withholding purposes, and therefore is not taxable for FICA purposes. The CSX Corporation v. United States case remained in appeal until March 6, 2008 when the US Court of Appeals ruled CSX did not establish that the severance payments satisfied the requirements for “non-wage” treatment as described in IRS SUB-Pay Plan Revenue Rulings from 1956 and 1990.
United States v. Quality Stores, Inc.
In October 2001, Quality Stores, Inc. closed its stores and distribution centers, involuntarily terminated its remaining workforce, provided its terminated employees with severance, withheld federal income tax and the employees’ share of FICA tax, and paid the employer’s share of FICA taxes on the severance pay. In 2002, Quality Stores filed refund claims with the IRS seeking to recover $1 million in FICA taxes. On February 23, 2010, the Michigan District Court rejected the reasoning of the US Court of Appeals in the case of CSX Corporation v. United States and affirmed that severance is not subject to FICA taxes because it is within the definition of SUB-Pay under US Code 3402(o). On September 7, 2012, the Court of Appeals for the Sixth Circuit affirmed the District Court's holding that payments made to employees pursuant to an employer’s severance plan are not “wages” for FICA tax purposes. On October 1, 2013 the Supreme Court agreed to decide the case.
The Supreme Court heard opening arguments in the United States v. Quality Stores case on January 14, 2014. This case will be the ultimate decision maker as to whether severance should be treated as SUB-Pay benefits. A decision should be rendered by summer 2014.
The Quality Stores case will have huge implications regarding the way many companies pay their existing severance packages to former employees. And while Quality Stores, Inc. is seeking about $1 million in FICA tax refunds on severance payments it made in 2001, the government has declared that the Internal Revenue Service (IRS) could owe more than $1 billion in thousands of protective FICA tax refund claims to individuals and businesses.
Instead of waiting for the Supreme Court’s decision, and with no assurance of a refund, there are alternatives to consider, particularly if the Supreme Court rules in part, or in favor of the IRS.
SUB-Pay Plans Provide FICA Tax Savings Now
While the Supreme Court takes the time to decide the Quality Stores case, the dispute over a FICA tax exemption on severance pay will continue with employers continuing to file refund claims with no assurance of a refund. However, severance payments made from a SUB-Pay Plan written in compliance with IRS Revenue Ruling 56-249 and 90-72 is the only way for an employer and their separated employees to receive a FICA tax exemption on payments made to an involuntary laid-off workforce. SUB-Pay Plans are also the only way an employer can utilize their paid-in asset of state UI taxes to supplement an employee’s state unemployment insurance benefits for an increased savings. In addition, SUB-Pay benefits are exempt from FUTA and SUTA taxes, and they are considered “non-wages” against the receipt of state unemployment insurance benefits.