The November 2003 Journal of Accountancy included a detailed account of how companies may benefit from a recent U.S. Court of Federal Claims decision in CSX Corp. by filing protective claims to recover Social Security and Medicare taxes on severance payments to former employees (see “ In the Money ?” JofA , Nov.03, page 73). The author has received a number of calls and e-mails about some aspects of the article. Here are some of the queries readers had.
Question: The article said IRS appeals rights in the case have lapsed. My understanding is the appeals rights in CSX are still pending. Which is correct?
Answer: Rule 59(a)(2) of the U.S. Court of Federal Claims says parties may file an appeal “at any time while a suit is pending before it, or after proceedings for review have been instituted, or within two years after the final disposition of the suit.” On October 31, 2003, the court issued its final opinion in CSX. According to the Department of Justice, the “final disposition” of this case could be as early as April 2004 after the court determines the monetary awards to CSX. The IRS appeals clock will begin to run when this occurs. The original article was incorrect: It has not yet begun to run.
The major issue is filing claims and receiving refunds for overpaid employment taxes. Regardless of an appeal by either party, the IRS still controls the strings and could dispute any requested refund claim. The agency has been silent and refuses to issue any comment on the case. This leaves the cost of litigation as a risk companies face in filing claims. Depending on the amount of potential refund, companies should consider filing a protective claim until the matter is resolved. Remember, employers only have until April 15, 2004, to file either form 843 or 941c for the payroll year ending December 31, 2000. If the IRS chooses not to appeal or if it acquiesces in the matter, this would protect a refund request against an untimely filing argument.
Question: The article says “lump sum and annuity type payments also may qualify.” The judge in CSX talks about the Eighth Circuit Court of Appeals opinion. Why doesn’t he apply it to this case? It appears that even if the lump sum is involuntary and the employee’s termination is imminent, the payment is still considered wages subject to FICA.
Answer: The federal claims court ruled on the nature of the lump sum payments in CSX. It did not compare the payment for contract rights in that case with the payment for relinquishment of tenure in North Dakota State Univ. v. United States, 255 F3d 599 (8th Cir. 2001). The claims court found the types of payments employees received were wages and as such taxable under the employment tax law. It did not determine whether lump sum payments qualified as supplemental unemployment compensation benefits (SUCBs).
Of the three types of severance payments the case covers, the federal claims court agreed that only the first payments—ones to former employees pursuant to a plan because of the employee’s involuntary separation from service—were SUCBs and therefore not subject to Social Security, Medicare or federal unemployment taxes.
The most important aspect of the contract termination argument is what the court said about the payments: “Because the rights being surrendered are integral to the employment relationship—they are part and parcel of the job protections and job benefits to which the employee may lay claim in return for his or her labor—they must be considered wages.” This statement applies to both lump sum and annuity payments. The key is how the employer determined severance payments and not how it paid them. Employers need to consider this when making future severance payments to employees under a SUCB plan.
Question: Do individual actions under employment contracts meet the requirements for a reduction-in-force plan as outlined in IRC section 3402(o)?
Answer: The court did not consider what qualifies as a plan. CSX itself is the common parent of a consolidated group of railroad companies that employs union workers. As such the company probably has numerous plans in force. The laws and regulations regarding SUCBs are not definitive on what elements are required to have a plan other than revenue rulings 56-249 and 90-72, which the court’s action neutralized. As in many IRS matters, the preponderance of plan components should exist. CPAs can look to employment contracts, employee manuals, policies and procedures and interoffice memos to establish elements of a plan, all of which must have been in place before the employee was terminated.
Question: The article mentions the IRS has issued guidance in Supplemental Circular E involving SUCBs. Could you please refer me to the correct pages?
Answer: The guidance is located in Publication 15-A , which readers can download at www.irs.gov . Look on pages 10 and 11. However, in CSX the court found that revenue ruling 56-249 and subsequently ruling 90-72 (the basis for the topic in Publication 15-A ) were not relevant because the former offered no analysis to explain why the plan conditions it recited are sufficient to take the payments in question outside the definition of wages. Absent an explanation of its result, the court said revenue ruling 56-249 can “have no persuasive force.” The court also said the criteria in the ruling did not become part of section 3402(o) when Congress made other changes to the law.
CPAs should use revenue rulings 56-249 and 90-72 as an indication of the potential direction the IRS will take when a company files a claim. If the IRS disputes a claim, it may be on the basis of these rulings. Knowing the federal claims court’s decision in this case will only help CPAs answer IRS objections.
Question: Are terminations of individuals based on job performance or incompatibility covered under SUCBs when the company later refills the job?
Answer: Section 3402(o) defines SUCBs 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 such benefits are includible in the employee’s gross income.”
The key here is “resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions.” A termination and immediate rehire of an employee, where severance is paid, does not fit the definition of a SUCB. How long a position remains open will depend on the facts and circumstances of the particular case.
DOUGLAS LETSCH, CPA, is an adjunct professor at Walden University in Minneapolis, where he teaches accounting and finance. He also consults on corporate tax and finance strategies and is pursuing his PhD in finance. His e-mail address is firstname.lastname@example.org .