US Supreme Court to rule on whether severance pay should be taxable

Decision could yield large tax refunds to companies
By Lawrence Hurley and Patrick Temple-West
||Last Updated: 10/02/2013

WASHINGTON (Reuters) — The U.S. Supreme Court agreed on Tuesday to consider whether severance pay to workers laid off involuntarily is subject to federal payroll tax in a case the Obama administration has warned could affect $1 billion in tax refund claims.

The dispute, which pits defunct rural retailer Quality Stores Inc against the U.S. Internal Revenue Service, involves the Federal Insurance Contributions Act tax, or FICA. The tax helps finance two major social programs, Social Security retirement pensions and Medicare health insurance for the aged.

FICA taxes are paid in part by the employer and in part by the employee, whose share is normally withheld from paychecks.

Midwest-based Quality Stores served mainly farmers and rural people. It went bankrupt in 2001 and closed all 300 of its stores. Thousands of workers were laid off, with severance pay, on which the company paid and withheld FICA taxes.

The company in 2002 claimed an IRS refund for just over $1 million in FICA taxes, roughly half paid by the company and half withheld from the severance pay.

The retailer argued that severance pay should not be subject to FICA taxes. The IRS thought otherwise, saying severance pay, like any other wage, is taxable for FICA purposes.

"The severance payments at issue here are clearly 'wages' for FICA purposes," the government said in an August filing.

Robert Hertzberg, a partner with Pepper Hamilton in Michigan, who represents Quality Stores' creditors, said: "It's an issue that needs to be decided by the Supreme Court."

The creditors expect to collect about $800,000 in interest if the court rules for Quality Stores, Hertzberg said.

"The government has a huge stake in this decision because of the exposure they have to other taxpayers," he added.

The IRS could not be reached for comment on Tuesday.

Recession echoes

The severance FICA issue has been disputed for years, but "rose from the ashes like the phoenix because of the recession," said Marianna Dyson, a lawyer with Miller & Chevalier.

The case has implications for many companies that paid taxes on severance to workers laid off in the 2007-2009 recession. Many corporations have claimed refunds that could be paid if Quality Stores prevails, tax lawyers said on Tuesday.

The 6th U.S. Circuit Court of Appeals ruled in September 2012 that both Quality Stores Inc and its former employees could claim a refund from the IRS. The federal government appealed that decision to the Supreme Court.

In an earlier, divergent opinion in 2008, a federal appeals court ruled against railroad group CSX Corp, saying it was liable for FICA tax on severance.

The Obama administration said in court papers there are more than 2,400 refund claims pending on the same issue.

The court's order on Tuesday said Justice Elena Kagan is taking no part in the case. As is customary court practice, she did not give a reason. Kagan has been sitting out administration disputes from when she served as U.S. solicitor general, before her August 2010 Supreme Court appointment.

Oral arguments and a decision are due in the court's coming term, which starts on Oct. 7 and ends in June. The case is United States v. Quality Stores Inc. No. 12-1408.

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