Client Publication
March 2004
Possible Refund Opportunity for FICA
and FUTA Taxes on Involuntary
Severance Payments in RIFs
Overview
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.
In the past several years, many employers have
implemented significant reductions in force for
which claims for refunds of any FICA and Federal
Unemployment Tax Act (“FUTA”) taxes paid could
be made on the basis of CSX.3 To rely on CSX as a
basis for a protective refund claim, the severance
payments must have been made pursuant to a
reduction in force plan and paid to employees who
were involuntarily separated from employment.
Claims for refunds for FICA and FUTA taxes are in
practice generally subject to a three-year statute of
limitations that runs from the time that the relevant
tax return was filed or was deemed filed.4 April 15,
2004 and April 15, 2005 are the deadlines for filing
refund claims with respect to FICA taxes paid as a
result of reductions in force that occurred in 2000
and 2001, respectively. The deadline for filing
refund claims will generally be January 31, 2005
with respect to FUTA taxes paid as a result of
reductions in force that occurred in 2001.
which were established by governing regulatory
rulings or collective bargaining agreements.
The affected employees received three types of
reduction in force payments from CSX depending
upon the employment status of the recipient:
• severance payments made to those employees
on lay-off status;
• payments made to employees who were on
“stand-by” status (employees whose full-time
positions were eliminated but who remained
subject to recall by CSX Corporation on an asneeded basis); and
• separation payments to employees (including
those on stand-by status) in exchange for
relinquishment of their current employment
with CSX Corporation.
CSX withheld the employee portion of the FICA
taxes on the reduction in force payments, paid the
applicable employer component and remitted the
aggregate amount to the Internal Revenue Service
(“IRS”). Some time thereafter, CSX filed timely
claims for refunds with respect to the FICA taxes
paid on its own behalf and on behalf of the affected
employees who either consented to participate in the
refund claim or could not be located by CSX. The
basis for the refund claims was that the reduction in
force payments did not constitute taxable wages for
FICA purposes. In response to CSX’s refund
claims, the IRS conducted an administrative review,
but ultimately disallowed the claims. CSX then filed
suit in the Claims Court, seeking a determination
that the reduction in force payments were not subject
to FICA taxes.
The Decision
The Facts of CSX
Between 1984 and 1990, the railroad concern CSX
Corporation, Inc. (“CSX”) implemented reductions
in force that resulted in the termination of
approximately 20,000 employees (out of an
aggregate population of 54,000). The affected
employees were entitled to certain reduction in force
payments from CSX, the amount and duration of
CSX based its claim for refunds on the argument that
the Internal Revenue Code of 1986, as amended (the
“Code”), imposes FICA taxes only on “wages” as
such term is defined in Section 3121(a) of the Code,
which expressly does not include “supplemental
unemployment compensation benefits” as defined in
Section 3402(o) of the Code.
2
Section 3121(a) of the Code defines “wages” for
FICA purposes as “all remuneration for employment,
including the cash value of all remuneration
(including benefits) paid in any medium other than
cash,” with some specific exclusions. The Code in
Section 3401(a) also includes a separate definition of
“wages” for purposes of income tax withholding,
being “all remuneration (other than fees paid to a
public official) for services performed by an
employee for his employer, including the cash value
of all remuneration (including benefits) paid in any
medium other than cash,” again with some specific
exclusions. CSX argued that the definitions of
“wages” in the Code provisions relevant to FICA
taxes and to income taxes are so substantially similar
that interpretations of the term in one context should
also apply in the other.
CSX noted that although Section 3402(o) of the
Code (entitled “Extension of withholding to certain
payments other than wages”) excludes supplemental
unemployment compensation benefits from the
definition of wages per se, the Section nevertheless
subjects these payments to withholding for income
tax purposes: “[A]ny supplemental unemployment
compensation benefit paid to an individual . . . shall
be treated as if it were a payment of wages by an
employer to an employee.”
CSX argued that, because supplemental unemployment
compensation benefits are excluded from the definition
of “wages” in the income tax context, such payments
must also be excluded from “wages” for FICA
purposes. CSX argued further that, because the Code
does not contain a provision for the imposition of FICA
taxes on such payments analogous to Section 3402(o)
in the income tax context, supplemental unemployment
compensation benefits are not subject to FICA taxes.
The Claims Court accepted CSX’s arguments,
finding that “barring differences in the two statutes,
the fundamental definition of wages under the FICA
and income-tax withholding statutes are to be
understood as being identical.” On this basis
supplemental unemployment compensation benefits
were neither wages nor remuneration for services
and not subject to taxation under FICA. The court
noted that, in order for such benefits to be subject to
FICA taxes, they would need to be expressly
included as taxable under Section 3121(a) of the
Code as was done for income tax withholding under
Section 3402(o) of the Code. Because there is no
specific inclusion of supplemental unemployment
compensation benefits in Section 3121(a) of the
Code, the Claims Court concluded that FICA taxes
should not be imposed on such benefits.
The Claims Court then went on to address whether
the three types of reduction in force payments made
by CSX constituted supplemental unemployment
compensation benefits. Section 3402(o) of the Code
defines “supplemental unemployment benefits” as
“amounts which are paid to an employee pursuant to
a plan to which the employer is a party, because
of an employee’s involuntary separation from
employment (whether or not such separation is
temporary), resulting directly from a reduction in
force, the discontinuance of a plant or operation, or
other similar conditions, but only to the extent
includible in the employee’s gross income.” The
court concluded that the payments at issue were
made as a result of reductions in force at CSX, and
focused the remainder of its analysis on the
characteristics of the separation of employment. The
Claims Court, however, did not address the issue of
whether the payments were made pursuant to a plan.
The Claims Court found that one type of reduction
in force payment—severance payments made to
employees involuntarily laid off by CSX—were
supplemental unemployment compensation benefits
and were not subject to FICA taxation. The court
reasoned that the affected employees were not
performing services for CSX and had effectively
experienced a separation from employment at the
time of receipt of such payments.
The Claims Court found that the other types of
reduction in force payments—payments made to
employees who were on stand-by status and
separation payments to employees in exchange for
relinquishment of their current employment with
CSX—did not constitute supplemental unemployment
compensation benefits and were subject to FICA
taxes. With respect to payments to those employees
on stand-by status, the court found that these
employees had not experienced a separation from
employment because they were still carried on the
CSX payroll, obliged to remain subject to recall on an
as-needed basis and compensated for all days actually
worked. With respect to the separation payments
made to employees in exchange for a relinquishment
of their current position with CSX, the court found
that the separation from employment was voluntary
on the part of these employees.
Implications
Under CSX, severance payments to terminated employees
that constitute supplemental unemployment compensation
benefits may not be subject to FICA and FUTA taxation.
As noted above, for severance payments to qualify as
supplemental unemployment benefits, such payments
must have been made pursuant to a plan and the separation
from employment must have been involuntary on the part
of the employee and due to a reduction in force.
Caution, however, is warranted about the extent to
which CSX should be relied upon because the
decision is still subject to appeal and the IRS has
not yet announced its future position on CSX.
In addition, because the Claims Court did not
address what constitutes a “plan” for purposes of
supplemental unemployment compensation benefits,
the applicability of CSX in the negotiated agreement
context is unclear. Furthermore, an employer
seeking to rely on CSX should consider whether it
treated the affected employees at the time severance
payments were made as having an involuntary
separation of employment for all purposes. For
3
example, the ability of the affected employees to
contribute a portion of the severance payments to the
employer’s 401(k) plan or the commencement of the
COBRA election period after payment of severance
has ceased may provide a basis for a determination
that the affected employees had not experienced a
separation from employment at the time the
severance payments were made.
In light of the tentative status of CSX, it may be
prudent to file protective refund claims with the IRS
with respect to any FICA and FUTA taxes paid on
severance payments that qualify under CSX and for
which the statute of limitations has not yet expired.
Filing protective refund claims now, while the final
outcome of CSX is unknown, may preserve the
refund claims until the law is settled in this area.
In general, a valid protective refund claim should set
forth in detail the grounds upon which the refund is
claimed and the supporting facts, be verified under
penalty of perjury, be submitted on the appropriate
form and be filed with the appropriate IRS center.
The grounds and facts set forth must be sufficient to
provide the IRS an opportunity to substantively
review the claim.
To make protective refund claims for FICA and
FUTA taxes on the basis of CSX, an employer
should file IRS Forms 941c and 843 for each year
for which a refund is sought, respectively, cite CSX
as the grounds for the claim, provide supporting
facts relating to the reductions in force and
severance payments, and provide calculations of the
refund amount. When an employer makes a claim
for a refund of FICA taxes, generally the employer
must certify on Form 941c that it has either repaid
the tax to its employees or that it has obtained their
written consent to the refund.5 For protective refund
claims based on CSX, this certification should not be
necessary to preserve the claim or receive an IRS
determination. The Federal Circuit Court has held
that an employer seeking a refund of the employee
portion of payroll taxes is not required to certify
repayment or consent before filing a refund claim,
because such certification does not affect the
notification to the IRS of the grounds on which the
refund is sought. The IRS has also taken the
position that obtaining the employee consents
perfects a refund claim but does not validate a claim
(or, rather, the lack of employee consent does not
invalidate a refund claim).6 Thus, an employer may
demonstrate compliance with the certification
requirement after a determination is made on the
actual merits of the refund claim.
For future reductions in force that occur while the
final outcome of CSX is pending, a prudent course of
action would be to pay the FICA and FUTA taxes
and then file for a refund as above.
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
New York
Henry C. Blackiston, III
John J. Cannon, III
Jeffrey P. Crandall
Kenneth J. Laverriere
Linda E. Rappaport
George Spera
(+1 212) 848-4000
London
Doreen E. Lilienfeld
(+44 (0)20) 7655 5000
Tax
Washington, D.C.
B. John Williams, Jr.
(+1 202) 508-8100
London
Bernie J. Pistillo
(+44 (0)20) 7655 5000
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.