The IRS says its mission is to help taxpayers “understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.” That looks great on paper but what happens when even the courts can’t agree on whether certain income is taxable? That’s a good question and when it comes to severance pay, the U.S. Supreme Court is expected to step in and determine the issue with some finality.
In this economy, companies are constantly relocating and downsizing. Frequently, businesses use severance packages to ease the disruption to workers. The IRS says that severance pay is a substitute for continued wages and is therefore taxable. It’s not the income taxes that are at issue, however. The fight is over Medicare and Social Security taxes. And that’s where the lines begin to get blurry.
The U.S. Court of Appeals for the Federal Circuit ruled in 2008 that severance payments were taxable for FICA purposes. FICA refers to both social security and Medicare taxes. For the last several years that was the “law of the land” and the position of the IRS. No longer.
In September of 2012, the 6th Circuit Court of Appeals (Michigan, Tennessee, Ohio & Kentucky) took a different position and ruled in favor of the taxpayers. Even though the taxpayers won that battle, the IRS doesn’t recognize the court’s decision and is appealing.
So who is right?
Unfortunately, we suspect the IRS will win this issue but the Supreme Court has shown a willingness to rule against the IRS in recent years. In other words, it is anybody’s guess.
The amount at stake is in the billions. The first $113,700 of wages is taxable for social security purposes. Both the employer and employee each contribute 6.2%. The Medicare tax has no cap and is generally taxed at 1.45% for both workers and employers.
Last year’s decision in the 6th Circuit resulted in tens of millions of dollars of refund requests from taxpayers located in Ohio, Kentucky, Michigan and Tennessee. Notwithstanding the clear mandate from the court, the IRS has stopped processing those refunds.
Only court can be right and the IRS is betting all its card that its interpretation is correct meaning no refunds.
What should taxpayers do?
First, don’t wait! The statute of limitations for filing a refund request is limited. Waiting for the Supreme Court to decide the issue may render some refund requests too late.
Unfortunately, employers should continue to withhold FICA taxes from severance checks. This includes companies located within the jurisdictional reach of the four states that make up the 6th Circuit Court of Appeals.
Immediately after withholding and turning over the taxes, employers should file a refund request. (You only have 36 months to file.)
Once your refund is denied (it will be), the law gives you just two years to appeal the denial of the refund in the Court of Claims or a U.S. District Court. The IRS has agreed to extend those deadlines but you have to ask before the two year time period expires.
Why would the IRS agree to extend deadlines? Like taxpayers, they don’t want to spend the money litigating claims that will soon be determined by the Supreme Court.
In many cases, employers are filing refund claims. If they do, affected workers who received a severance payment should determine if their former employer included them in the refund request. If not, individual workers can file their own refund request.
Employers needing guidance should contact a tax attorney. Our team of IRS attorneys have helped taxpayers – business & individuals – with a wide variety of tax audit and refund issues. For more information, contact attorney Bethany Canfield at or by telephone at (414) 223-0464. The author may also be contacted at or by telephone at (414) 704-6731 (direct). All inquiries are protected by the attorney – client privilege and kept in strict confidence.
Mahany & Ertl – America’s Tax Lawyers. IRS tax services available worldwide.
Post by Brian Mahany, Esq.