Was your company forced to downsize its staff the past few years while the economy struggled? It’s time to go “on the record” while the Supreme Court reviews the federal employment tax implications of severance pay.
Strategy: If your company paid Social Security and Medicare taxes on severance payments to discharged employees, consider filing a protective refund claim before April 15.
If the Supreme Court sides with the taxpayer in a landmark new case, your firm may be entitled to a significant tax refund. (Quality Stores, Inc., CA-6, 9/7/12, cert. granted 10/1/13)
The Supreme Court isn’t expected to issue its ruling until the summer, but the deadline for filing a protective refund claim for the 2010 tax year is April 15, 2014.
The claim secures the availability of a refund for the tax year in question.
Here’s the whole story: Generally, wages that are subject to income tax withholding are also treated as wages for federal employment tax purposes.
However, Supplemental Unemployment(SUB) are excluded from the definition of “wages” for federal employment tax purposes.
To qualify as SUB, payment must be:
- Made to an employee
- Pursuant to your company’s plan
- Due to an employee’s involuntary separation from employment
- As a direct result of a reduction in force, discontinuance of a plant or operation, or similar conditions
- Included in the employee’s gross income for federal income tax purposes.
Because severance payments are clearly wages for federal income tax purposes, the IRS has consistently maintained that severance payments to terminated workers are also subject to federal employment taxes.
Traditionally, the courts have agreed with the IRS, but now a district court in Michigan took a different approach. It said the payments in the Quality Stores case constituted SUB payments.
The 6th Circuit Court of Appeals affirmed the lower court’s ruling. The IRS appealed to the nation’s top court.
In the meantime, employers were left in a quandary. Should they withhold employment taxes from severance pay or risk a challenge from the IRS?
Faced with the choice, many companies opted to play it safe and hand over the taxes to the IRS.
Now these employers stand to benefit if the Supreme Court upholds the Quality Stores decision.
Tip: File the protective claim on Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.