Legal Considerations of SUB-Pay Plans
Origins of Supplemental Unemployment Benefit ("SUB-Pay") Plans
Since they were first introduced by organized labor and the Department of Labor in the early 1950's, and first issued in a Revenue Ruling by the IRS in 1956, SUB-Pay Plans have enabled employers to supplement the receipt of state unemployment insurance benefits for employees that experience an involuntary layoff. By establishing severance payments as SUB-Pay benefits, the payments are not considered wages for FICA, FUTA and SUI tax purposes, and employee FICA tax. To qualify for SUB-Pay benefits, the participant must be eligible for state unemployment insurance benefits and the separation benefit must be paid on a periodic basis.
FICA Tax Protective Refund Claims vs. FICA Tax Savings
In response to a September 7, 2012 Sixth Circuit Court’s decision in the case of United States v. Quality Stores, Inc., many employers are filing “FICA tax protective refund claims” even though there is no assurance that their refunds will be approved. However, many Fortune 1000 companies, and their downsized employees, are currently receiving an immediate and guaranteed FICA tax savings by modifying their severance plan to a SUB-Pay Plan.
Since 2002, District, Federal Circuit and US Appeals Courts have been considering whether severance pay is considered wages for FICA tax purposes. As this case proceeds through the courts, employers have filed for more than $7 billion in protective refund claims for FICA taxes paid on severance payments.
CSX Corp. v. United States
During 1984 to 1990, CSX reduced its workforce significantly and paid the employer’s share of FICA taxes on the severance payments. CSX filed claims for a FICA tax refund on the basis that severance is SUB-Pay as defined by an Internal Revenue Code for income tax withholding purposes, and therefore is not taxable for FICA purposes. The CSX Corporation v. United States case remained in appeal until March 6, 2008 when the US Court of Appeals ruled CSX did not establish that the severance payments satisfied the requirements for “non-wage” treatment as described in IRS SUB-Pay Plan Revenue Rulings from 1956 and 1990.
United States v. Quality Stores, Inc.
In October 2001, Quality Stores, Inc. closed its stores and distribution centers, involuntarily terminated its remaining workforce, provided its terminated employees with severance, withheld federal income tax and the employees’ share of FICA tax, and paid the employer’s share of FICA taxes on the severance pay. In 2002, Quality Stores filed refund claims with the IRS seeking to recover $1 million in FICA taxes. On February 23, 2010, the Michigan District Court rejected the reasoning of the US Court of Appeals in the case of CSX Corporation v. United States and affirmed that severance is not subject to FICA taxes because it is within the definition of SUB-Pay under US Code 3402(o). On September 7, 2012, the Court of Appeals for the Sixth Circuit affirmed the District Court's holding that payments made to employees pursuant to an employer’s severance plan are not “wages” for FICA tax purposes.
SUB-Pay Plans Provide FICA Tax Savings Now
While the IRS continues its appeal of the latest decision in Quality Stores to the US Supreme Court, the dispute over a FICA tax exemption on severance pay could continue for years with employers continuing to file refund claims with no assurance of a refund. However, severance payments made from a SUB-Pay Plan written in compliance with IRS Revenue Ruling 90-72 is the only way for an employer and their separated employees to receive a FICA tax exemption on payments made to an involuntary laid-off workforce. SUB-Pay Plans are also the only way an employer can utilize their paid-in asset of state UI taxes to supplement an employee’s state unemployment insurance benefits for an increased savings. In addition, SUB-Pay benefits are exempt from FUTA and SUTA taxes, and they are considered “non-wages” against the receipt of state unemployment insurance benefits.