Quality Stores Ruling Could By Curtis Tatum, Esq.
Cause Payroll Headaches
On December 13, the APA filed an amicus brief in the Quality Stores case (APA Brief) urging the Supreme Court to uphold the Sixth Circuit Court of Appeals' decision that supplemental unemployment benefits payments (SUB payments) paid to involuntarily terminated employees are not taxable wages for FICA purposes. On January 14, the U.S. Supreme Court heard arguments in that same case. Both a written transcript and an audio recording of the proceedings are available on the Supreme Court's website.
What's at Stake
"Though the tax refund at issue in this case is small - about $1 million - the Obama administration has warned in court filings that the Internal Revenue Service could owe more than $1 billion in thousands of tax refund claims to individuals and businesses if the appeals court ruling is upheld," Reuters' Patrick Temple-West reported in his article, Taxes on Severance Pay? Supreme Court to Hear Case.
That number may be understated, however. Mary Hevener, a partner with Morgan, Lewis & Bockius LLP, and tax counsel to the APA, said she has filed claims on behalf of her clients since 1992, while some other lawyers have been filing since 1988.
The APA brief notes that the APA has "a significant interest in the outcome of this case because many of its members process downsizing payments like the ones at issue here." The APA brief warns that one consequence of a ruling in favor of the government could be "an administrative quagmire for multistate employers, which would end up with different federal payroll rules in different jurisdictions."
Government's Oral Argument
Eric J. Feigin, Esq., Assistant to the Solicitor General, represented the government before the Court. He argued that "the payments in this case fall squarely under FICA's definition of wages, which includes all remuneration for employment."
He noted that the Court previously "construed the term 'employment' broadly to encompass the entire employer-employee relationship." Feigin stated that "the payments here, which were paid only to Respondent's employees and were keyed to the employees' positions, salary levels, and length of service, clearly were part of the employer-employee relationship."
Anticipating an argument from Quality Stores concerning the effect of Section 3402(o), Feigin asserted that the provision "is a substantive rule of income tax withholding," and "it has no bearing on the definition of wages for purposes of FICA."
The APA brief also addresses Section 3402 and reaches a different conclusion. It supports: "the definition of 'supplemental unemployment compensation benefits' that Congress set forth in sections 3402(o)(2)(A) & 501(c)(17)(D) of the Tax Code as benefits 'which are paid to an employee because of his involuntary separation from the employment of the employer (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.' These benefits were not treated as wages for FICA purposes."
Oral Argument on Behalf of Quality Stores
Robert S. Hertzberg, Esq., represented Quality Stores before the Court. He opened his argument by noting that "the Government agrees that some SUB payments are not wages. Where the dispute lies is what SUB payments are covered by FICA and which are not. If the payments meet the definition of SUB payment under the statute, then they are not wages and not subject to FICA."
Regarding Section 3402(o), Hertzberg stated that SUB payments "should be treated as if they are wages. If they were already wages, there would have been no necessity of treating them [as] if they were wages. If you also look at the title of the section, it says 'other than wages.' It's clear that, if it was wages, they wouldn't use the term 'other than wages.'"
Questions Posed by the Justices
During their arguments, both Feigin and Hertzberg faced tough questions from several of the Justices.
Justice Anthony Kennedy asked Feigin, "Either then or now, were the supplemental unemployment benefit payments subject to FICA withholding or are they now exempt under the present?" Feigin answered, "No, supplemental unemployment benefits as defined by the IRS in its revenue rulings were subject neither to withholding nor to taxation under FICA."
In answer to Kennedy's follow-up question concerning the effect of Section 3402(o), Feigin stated that the SUB payments "still were not subject to FICA tax."
Justice Samuel Alito asked Feigin what the effect would be if the payments "were not keyed to length of service and to salary," and instead were "flat severance payments."
Feigin asserted, "We still think they would meet the basic definition of 'wages' under FICA...and would still count as wages and be taxable under FICA. I think this case is even easier than that because payments were clearly keyed to critical aspects of the employment relationship."
Alito asked Hertzberg whether the SUB payments would be subject to FICA taxation if Section 3402(o) did not exist. Hertzberg answered in the negative, "because, if you look at how they are treated, even the government acknowledges that some supplemental unemployment benefits are not wages." He went on to cite a 1977 revenue ruling that "the Government issued [that] said that supplemental unemployment benefits of any kind are not -- are not -- wages and subject to FICA."
Alito asked Hertzberg about the effects of Section 3402 and whether all or only some types of SUB payments "are not wages."
Hertzberg replied, "I think the language is clear because...in the title it says 'other than wages.' If any of them were wages they wouldn't have used the word 'other than wages.'" He added that "if they were already wages, there'd have been no need for the statute."
Justice Ruth Bader Ginsburg raised an interesting public policy issue concerning state unemployment benefits. She asked, "What happens to the state compensation schemes which the revenue rulings seem to have been trying to accommodate?"
Feigin answered that a ruling in favor of the government that also invalidated revenue ruling 90-72 “might have some effect on individuals' eligibility for unemployment benefits under state law in those states that incorporate the federal definition of wages as part of the calculation for eligibility for state unemployment benefits." He noted that, "if that creates any bad results, states will be able to fix them."
In his SCOTUSBlog article, "Argument Report: Supplemental unemployment benefit payments are likely 'wages' under FICA," Santa Clara University law Professor Bradley Joondeph predicts that "in Quality Stores itself, the Court is likely to say little more than this: SUB payments like those made by Quality Stores are wages under FICA because they plainly constitute 'remuneration for employment.' And that is the only question the Court really needs to answer."
The Court's decision is expected sometime this spring.