2 Section 3121(a) of the Code defines - PDF document

2 Section 3121(a) of the Code defines “w
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 includibl

e in the employee’s gross income.” The
e 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 , 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 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 in the negotiated agreement context is unclear. Furthermore, an employer seeking to rely on 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 , 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 q
taxes paid on severance payments that qualify under and for which the statute of limitations has not yet expired. Filing protective refund claims now, while the final outcome of 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 , an employer should file IRS Forms 941c and 843 for each year for which a refund is sought, respectively, cite 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. For protective refund claims based on , 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). 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 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 52 Fed. Cl. 208 (Fed. Cl. 2002), granting summary judgment on other issues, 58 Fed. Cl. 341 (Fed. Cl. 2003). 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 thMedicare 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. Although CSX did not address

the FUTA tax, CSX should apply to FUTA
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.” 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). 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 emploportion of the FICA taxes. 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 YorkHenry C. Blackiston, III John J. Cannon, III Jeffrey P. Crandall Kenneth J. Laverriere Linda E. Rappaport George Spera (+1 212) 848-4000 Doreen E. Lilienfeld (+44 (0)20) 7655 5000 B. John Williams, Jr. (+1 202) 508-8100 LondonBernie J. Pistillo (+44 (0)20) 7655 5000 www.shearman.com HEARMAN TERLING LLP599 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. Client Publication March 2004 Possible Refund Opportunity for FICA Overview A relatively recent decision by the U.S. Court of Federal Claims—CSX Corp v. United States —may provide an opportunity for employers to claim refunds of payroll taxes on severance paid to involuntarily terminated employees