A History of Legal Precedent

for a Solid Business Practice

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, and on March 25, 2014 the Court unanimously rejected a $1 million refund bid by Quality Stores, and said severance payments the company made to 3,100 people were subject to FICA taxes.  In addition, more than $1 billion in FICA tax protective refund claims filed by employers across the country will not be paid by the IRS.

This case had broad implications on whether employers continue to provide SUB-Pay Plans, which are linked to the receipt of state unemployment insurance (“UI”) benefits which, pursuant to the IRS’s administrative position going back to the 1950s, is not subject to FICA or FUTA taxes.  Under the Court’s ruling SUB-Pay Plans will remain valid.

SUB-Pay Plans Provide FICA Tax Savings Now

Now that the Supreme Court had made their decision in the Quality Stores case, the dispute over a FICA tax exemption on severance pay is over.  However, severance payments made from a SUB-Pay Plan written in compliance with IRS Revenue Ruling 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.


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