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TAX MATTERS

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December 2012

FICA Exemption for SUB Payments Affirmed

The Sixth Circuit affirmed a bankruptcy and district courts' determinations that severance payments by a bankrupt company to its former employees were supplemental unemployment benefit (SUB) payments not subject to FICA tax (In re Quality Stores, Inc., No. 10-1563 (6th Cir. 9/7/12); see previous Tax Matters coverage, “SUB Payments Are Not FICA Wages,” June 2010, page 79).


The bankruptcy and district courts had held that Sec. 3402(o), which specifies that SUB payments are subject to income tax withholding, and the statute’s legislative history indicate that SUBs are not wages under the statute’s definition or the nearly identical definition in Sec. 3121(a) of wages subject to FICA. The Sixth Circuit agreed, also rejecting the IRS’s arguments that Rowan Cos., 452 U.S. 247 (1981), which held that the two wage definitions are the same, was eroded by subsequent enactments and cases. The latter include last year’s Mayo Foundation for Medical Ed. & Research, 131 S. Ct. 704 (2011), which concerned FICA assessments on stipends paid to hospital medical residents. The Sixth Circuit stated that Mayo did not address the definition of “wages”; thus, the case added “nothing of significance to our legal analysis.”

The Sixth Circuit also acknowledged its split on the issue from the holding of the Federal Circuit in CSX Corp., 518 F.3d 1328 (Fed. Cir. 2008). In that case, the Federal Circuit relied on a definition of SUBs in a line of IRS revenue rulings distinguishing them from FICA-taxable “dismissal pay,” one the Sixth Circuit said was not supported by the “express statutory definition” provided in Sec. 3402(o).

R&D Credit Limited to Research Supplies

The Second Circuit affirmed the Tax Court’s decision restricting Union Carbide’s Sec. 41 research and development credit to the cost of supplies used in research and not those also used in the production of products resulting from the research (Union Carbide Corp., No. 11-2552 (2d Cir. 9/7/12), aff’g T.C. Memo. 2009-50). The ruling concerned three projects. In two, costs of materials Union Carbide claimed were paid or incurred in the conduct of qualified research under Sec. 41(b)(2)(A)(ii) the Tax Court found were for raw materials used to make finished goods that would have been purchased regardless of whether Union Carbide had been engaged in qualified research. The third project, the Tax Court concluded, did not meet the “process of experimentation” test under Sec. 41(d)(1)(C). In regards to the first two projects, the Second Circuit agreed with the Tax Court that the disallowed expenses were, at best, indirect research costs excluded from the definition of qualified research expenses under Regs. Sec. 1.41-2(b)(2).

Drought Counties Listed for Livestock Replacement Extension

In Notice 2012-62, the IRS published a list of more than 1,800 counties and other localities in 38 states where it is extending the like-kind replacement period for involuntary conversions of livestock under Sec. 1033(e)(2)(B) for an additional year due to drought.

Sec. 1033(e) provides a four-year extended replacement period without recognition of gain for sale or exchange of livestock (not including poultry) solely due to drought, flood, or other weather-related conditions. The livestock must be held for draft, breeding, or dairy purposes and not include those the taxpayer would sell in the ordinary course of business. Under Sec. 1033(e)(2)(B), the four-year period may be extended further for weather-related conditions continuing for more than three years.

Notice 2006-82 provides that this additional extension will last through the first tax year ending after the first drought-free year (measured from Sept. 1 to Aug. 31) for the taxpayer’s applicable region. The first drought-free year for the applicable region is the first 12-month period that (1) ends Aug. 31; (2) ends in or after the last year of the taxpayer’s four-year replacement period; and (3) does not include any weekly period for which the National Drought Mitigation Center reports that any location in the applicable region is in severe, extreme, or exceptional drought. The applicable region includes the county that experienced the drought conditions that necessitated the sale of the livestock plus all contiguous counties. The drought counties are shown on maps archived at the center’s website, droughtmonitor.unl.edu. Rather than research those archives and compile the data manually, taxpayers may rely on the listing in Notice 2012-62 for the year ending Aug. 31, 2012.

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