Sixth Circuit Holds that Supplemental Unemployment Compensation Benefits Are Not 'Wages' Subject to FICA Taxation

In an important recent decision, United States v. Quality Stores, Inc., et al., Case No. 10-1563, 2012 U.S. App. LEXIS 18820 (6^th Cir., Sept. 7, 2012), the U.S. Court of Appeals for the Sixth Circuit held that supplemental unemployment compensation benefits (SUB payments) paid by a bankrupt company to its former employees were not wages subject to taxation under the Federal Insurance Contributions Act (FICA). Accordingly, the employer and its former employees were entitled to refunds of amounts paid to the Internal Revenue Service on account of FICA taxes from severance payments that had been made after the employer filed for bankruptcy. The Sixth Circuit declined to follow a contrary 2008 decision on the issue of the Federal Circuit, CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), the only other court of appeals decision to address the issue. The refund claim at issue in Quality Stores totals approximately $1 million (plus interest) and it is estimated that there are similar pending refund claims totaling over $4 billion.

Quality Stores has been a closely watched case. The Sixth Circuit's decision is an important precedent on several aspects of tax law, including the continuing validity of Rowan Cos. v. United States, 452 U.S. 247 (1981), and the interpretation of, and judicial deference to be afforded to, revenue rulings. It appears likely that the government will seek to have the Sixth Circuit's decision reviewed by the U.S. Supreme Court. In the meantime, Quality Stores will provide strong support to taxpayers seeking refunds of FICA taxes paid in connection with the many workforce reductions that have occurred during the Great Recession. Employers and other taxpayers should consult their tax advisors concerning the possible implications of this decision.