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Possible Refund Opportunity for FICA and FUTA Taxes on Involuntary Severance Payments in RIFs

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A relatively recent decision by the U.S. Court of Federal Claims—CSX Corp v. United States (“CSX”)1—may provide an opportunity for employers to claim refunds of payroll taxes on severance paid to involuntarily terminated employees.2 In CSX, the Claims Court held that severance payments made to employees who were terminated involuntarily pursuant to a reduction in force constitute “supplemental unemployment compensation benefits” and are not “wages” for purposes of imposing taxes under the Federal Insurance Contribution Act (“FICA”). It should be noted, however, that CSX is still subject to appeal to the U.S. Court of Appeals for the Federal Circuit, and caution is warranted with respect to its prospective application.
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by JUDY on April 26th, 2010 at 09:27 am
DO i PAY TAX ON 3,950 INVOLNTARILY RETIREMENT JOB SETTLEMENT
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Client Publication
March 2004

Possible Refund Opportunity for FICA
and FUTA Taxes on Involuntary
Severance Payments in RIFs
Overview
which were established by governing regulatory
rulings or collective bargaining agreements.
A relatively recent decision by the U.S. Court of Federal
Claims—CSX Corp v. United States (“CSX”)1—may
The affected employees received three types of
provide an opportunity for employers to claim refunds of
reduction in force payments from CSX depending
payroll taxes on severance paid to involuntarily
upon the employment status of the recipient:
terminated employees.2 In CSX, the Claims Court held
• severance payments made to those employees
that severance payments made to employees who were
on lay-off status;
terminated involuntarily pursuant to a reduction in force
constitute “supplemental unemployment compensation
• payments made to employees who were on
benefits” and are not “wages” for purposes of imposing
“stand-by” status (employees whose full-time
taxes under the Federal Insurance Contribution Act
positions were eliminated but who remained
(“FICA”). It should be noted, however, that CSX is still
subject to recall by CSX Corporation on an as-
subject to appeal to the U.S. Court of Appeals for the
needed basis); and
Federal Circuit, and caution is warranted with respect to
its prospective application.
• separation payments to employees (including
those on stand-by status) in exchange for
In the past several years, many employers have
relinquishment of their current employment
implemented significant reductions in force for
with CSX Corporation.
which claims for refunds of any FICA and Federal
Unemployment Tax Act (“FUTA”) taxes paid could
CSX withheld the employee portion of the FICA
be made on the basis of CSX.3 To rely on CSX as a
taxes on the reduction in force payments, paid the
basis for a protective refund claim, the severance
applicable employer component and remitted the
payments must have been made pursuant to a
aggregate amount to the Internal Revenue Service
reduction in force plan and paid to employees who
(“IRS”). Some time thereafter, CSX filed timely
were involuntarily separated from employment.
claims for refunds with respect to the FICA taxes
paid on its own behalf and on behalf of the affected
Claims for refunds for FICA and FUTA taxes are in
employees who either consented to participate in the
practice generally subject to a three-year statute of
refund claim or could not be located by CSX. The
limitations that runs from the time that the relevant
basis for the refund claims was that the reduction in
tax return was filed or was deemed filed.4 April 15,
force payments did not constitute taxable wages for
2004 and April 15, 2005 are the deadlines for filing
FICA purposes. In response to CSX’s refund
refund claims with respect to FICA taxes paid as a
claims, the IRS conducted an administrative review,
result of reductions in force that occurred in 2000
but ultimately disallowed the claims. CSX then filed
and 2001, respectively. The deadline for filing
suit in the Claims Court, seeking a determination
refund claims will generally be January 31, 2005
that the reduction in force payments were not subject
with respect to FUTA taxes paid as a result of
to FICA taxes.
reductions in force that occurred in 2001.
The Decision
The Facts of CSX
CSX based its claim for refunds on the argument that
Between 1984 and 1990, the railroad concern CSX
the Internal Revenue Code of 1986, as amended (the
Corporation, Inc. (“CSX”) implemented reductions
Code”), imposes FICA taxes only on “wages” as
in force that resulted in the termination of
such term is defined in Section 3121(a) of the Code,
approximately 20,000 employees (out of an
which expressly does not include “supplemental
aggregate population of 54,000). The affected
unemployment compensation benefits” as defined in
employees were entitled to certain reduction in force
Section 3402(o) of the Code.
payments from CSX, the amount and duration of



2
Section 3121(a) of the Code defines “wages” for
employment (whether or not such separation is
FICA purposes as “all remuneration for employment,
temporary), resulting directly from a reduction in
including the cash value of all remuneration
force, the discontinuance of a plant or operation, or
(including benefits) paid in any medium other than
other similar conditions, but only to the extent
cash,” with some specific exclusions. The Code in
includible in the employee’s gross income.” The
Section 3401(a) also includes a separate definition of
court concluded that the payments at issue were
“wages” for purposes of income tax withholding,
made as a result of reductions in force at CSX, and
being “all remuneration (other than fees paid to a
focused the remainder of its analysis on the
public official) for services performed by an
characteristics of the separation of employment. The
employee for his employer, including the cash value
Claims Court, however, did not address the issue of
of all remuneration (including benefits) paid in any
whether the payments were made pursuant to a plan.
medium other than cash,” again with some specific
The Claims Court found that one type of reduction
exclusions. CSX argued that the definitions of
“wages” in the Code provisions relevant to FICA
in force payment—severance payments made to
taxes and to income taxes are so substantially similar
employees involuntarily laid off by CSX—were
supplemental unemployment compensation benefits
that interpretations of the term in one context should
also apply in the other.
and were not subject to FICA taxation. The court
reasoned that the affected employees were not
CSX noted that although Section 3402(o) of the
performing services for CSX and had effectively
Code (entitled “Extension of withholding to certain
experienced a separation from employment at the
payments other than wages”) excludes supplemental
time of receipt of such payments.
unemployment compensation benefits from the
The Claims Court found that the other types of
definition of wages per se, the Section nevertheless
subjects these payments to withholding for income
reduction in force payments—payments made to
tax purposes: “[A]ny supplemental unemployment
employees who were on stand-by status and
separation payments to employees in exchange for
compensation benefit paid to an individual . . . shall
be treated as if it were a payment of wages by an
relinquishment of their current employment with
employer to an employee.”
CSX—did not constitute supplemental unemployment
compensation benefits and were subject to FICA
CSX argued that, because supplemental unemployment
taxes. With respect to payments to those employees
compensation benefits are excluded from the definition
on stand-by status, the court found that these
of “wages” in the income tax context, such payments
employees had not experienced a separation from
must also be excluded from “wages” for FICA
employment because they were still carried on the
purposes. CSX argued further that, because the Code
CSX payroll, obliged to remain subject to recall on an
does not contain a provision for the imposition of FICA
as-needed basis and compensated for all days actually
taxes on such payments analogous to Section 3402(o)
worked. With respect to the separation payments
in the income tax context, supplemental unemployment
made to employees in exchange for a relinquishment
compensation benefits are not subject to FICA taxes.
of their current position with CSX, the court found
that the separation from employment was voluntary
The Claims Court accepted CSX’s arguments,
on the part of these employees.
finding that “barring differences in the two statutes,
the fundamental definition of wages under the FICA
and income-tax withholding statutes are to be
Implications
understood as being identical.” On this basis
Under CSX, severance payments to terminated employees
supplemental unemployment compensation benefits
that constitute supplemental unemployment compensation
were neither wages nor remuneration for services
benefits may not be subject to FICA and FUTA taxation.
and not subject to taxation under FICA. The court
As noted above, for severance payments to qualify as
noted that, in order for such benefits to be subject to
supplemental unemployment benefits, such payments
FICA taxes, they would need to be expressly
must have been made pursuant to a plan and the separation
included as taxable under Section 3121(a) of the
from employment must have been involuntary on the part
Code as was done for income tax withholding under
of the employee and due to a reduction in force.
Section 3402(o) of the Code. Because there is no
Caution, however, is warranted about the extent to
specific inclusion of supplemental unemployment
which CSX should be relied upon because the
compensation benefits in Section 3121(a) of the
decision is still subject to appeal and the IRS has
Code, the Claims Court concluded that FICA taxes
not yet announced its future position on CSX.
should not be imposed on such benefits.
In addition, because the Claims Court did not
The Claims Court then went on to address whether
address what constitutes a “plan” for purposes of
the three types of reduction in force payments made
supplemental unemployment compensation benefits,
by CSX constituted supplemental unemployment
the applicability of CSX in the negotiated agreement
compensation benefits. Section 3402(o) of the Code
context is unclear. Furthermore, an employer
defines “supplemental unemployment benefits” as
seeking to rely on CSX should consider whether it
“amounts which are paid to an employee pursuant to
treated the affected employees at the time severance
a plan to which the employer is a party, because
payments were made as having an involuntary
of an employee’s involuntary separation from
separation of employment for all purposes. For


3
example, the ability of the affected employees to
as the grounds for the claim, provide supporting
contribute a portion of the severance payments to the
facts relating to the reductions in force and
employer’s 401(k) plan or the commencement of the
severance payments, and provide calculations of the
COBRA election period after payment of severance
refund amount. When an employer makes a claim
has ceased may provide a basis for a determination
for a refund of FICA taxes, generally the employer
that the affected employees had not experienced a
must certify on Form 941c that it has either repaid
separation from employment at the time the
the tax to its employees or that it has obtained their
severance payments were made.
written consent to the refund.5 For protective refund
claims based on CSX, this certification should not be
In light of the tentative status of CSX, it may be
necessary to preserve the claim or receive an IRS
prudent to file protective refund claims with the IRS
determination. The Federal Circuit Court has held
with respect to any FICA and FUTA taxes paid on
that an employer seeking a refund of the employee
severance payments that qualify under CSX and for
portion of payroll taxes is not required to certify
which the statute of limitations has not yet expired.
repayment or consent before filing a refund claim,
Filing protective refund claims now, while the final
because such certification does not affect the
outcome of CSX is unknown, may preserve the
notification to the IRS of the grounds on which the
refund claims until the law is settled in this area.
refund is sought. The IRS has also taken the
In general, a valid protective refund claim should set
position that obtaining the employee consents
forth in detail the grounds upon which the refund is
perfects a refund claim but does not validate a claim
claimed and the supporting facts, be verified under
(or, rather, the lack of employee consent does not
penalty of perjury, be submitted on the appropriate
invalidate a refund claim).6 Thus, an employer may
form and be filed with the appropriate IRS center.
demonstrate compliance with the certification
The grounds and facts set forth must be sufficient to
requirement after a determination is made on the
provide the IRS an opportunity to substantively
actual merits of the refund claim.
review the claim.
For future reductions in force that occur while the
To make protective refund claims for FICA and
final outcome of CSX is pending, a prudent course of
FUTA taxes on the basis of CSX, an employer
action would be to pay the FICA and FUTA taxes
should file IRS Forms 941c and 843 for each year
and then file for a refund as above.
for which a refund is sought, respectively, cite CSX

ENDNOTES

1 52 Fed. Cl. 208 (Fed. Cl. 2002), granting summary judgment on other issues, 58 Fed. Cl. 341 (Fed. Cl. 2003).
2 Employers and employees both pay taxes required by FICA (as defined above) to fund Social Security and Medicare. Social Security is
comprised of Old Age and Survivor’s Insurance and Disability Insurance, and Medicare benefits are provided by the Health Insurance
program. The employee share of the Social Security tax is 6.2% of applicable wages, up to a maximum $87,900 in 2004, and of the
Medicare tax is 1.45% of applicable wages, with no upper limit. The employee share of Social Security and Medicare taxes is withheld
from wages and matched by the employer, which then remits the aggregate amount to the IRS. FUTA (as defined above) imposes a
payroll tax on employers only; the FUTA tax is 6.2% of applicable wages (less credit for payments to state unemployment funds up to a
maximum of 5.4% of wages), up to a maximum of $7,000 in 2004.
3 Although CSX did not address the FUTA tax, CSX should apply to FUTA taxes because Section 3264(b) of the Code defines “wages” for
FUTA purposes in the same manner as for FICA; that is— “all remuneration for employment, including the cash value of all
remuneration (including benefits) paid in any benefit other than cash.”
4 Section 6511(a) of the Code provides that a claim for refund on overpayment of FICA and FUTA taxes must be filed within three years
from the date the return was filed or two years from the time the tax was paid, whichever is later. FICA taxes are reported on quarterly
tax returns that are generally due one month after the end of each calendar quarter. See Treas. Reg. §§ 31.6011(a)-1(a), -3(a) and –4(a).
Section 6513(c) of the Code, however, provides that, for purposes of Section 6511(a) of the Code—the statute of limitations for refund
claims—returns for FICA taxes are deemed to be filed and such taxes deemed to have been paid on April 15 of the succeeding calendar
year for which the wages subject to the FICA taxes were earned. FUTA taxes are reported on an annual return that is generally due on
January 31 with respect to wages subject to the tax that were paid during the preceding calendar year. See Treas. Reg. § 31.6071(a)-1(c).
In the event that an employer has made timely deposits of its unemployment taxes during the preceding year, the tax return for FUTA
taxes may be filed by February 10th of such year. See Code Section 6513(e).
5 See Treas. Reg. § 31.6402(a)-2(a)(2). Case law has established that an employer has a duty to protect its employees’ rights to recover the
overpaid employee portion of the FICA taxes. See Atlantic Department Stores, Inc. v. U.S., 557 F.2d 957 (2d Cir. 1977). However, even
if an employer’s reasonable attempts to obtain consents are unsuccessful, the employer may claim a refund of the overpaid employer
portion of the FICA taxes.
6 See Chicago Milwaukee Corp. v. U.S., 40 F.3d 373, 376-77 (Fed. Cir. 1994).


4

This memorandum is intended only as a general discussion of these issues. It should not be regarded as
legal advice. We would be pleased to provide additional details or advice about specific situations if
desired. For more information on the topics covered in this issue, please contact:
Executive Compensation & Employee Benefits
Tax
New York
London
Washington, D.C.
London
Henry C. Blackiston, III
Doreen E. Lilienfeld
B. John Williams, Jr.
Bernie J. Pistillo
John J. Cannon, III
(+44 (0)20) 7655 5000
(+1 202) 508-8100
(+44 (0)20) 7655 5000
Jeffrey P. Crandall
Kenneth J. Laverriere
Linda E. Rappaport
George Spera
(+1 212) 848-4000
www.shearman.com
©2004 SHEARMAN & STERLING LLP
599 Lexington Avenue, New York, NY 10022
Under the regulations of some jurisdictions, this material may constitute advertising. As used herein, “Shearman & Sterling”
refers to Shearman & Sterling LLP, a limited liability partnership organized under the laws of the State of Delaware.


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