A federal district court in Michigan has held that certain supplemental unemployment compensation benefits (SUB pay) are not "wages" subject to Federal Insurance Contributions Act (FICA) taxation.  In general, SUB pay includes amounts that are paid to an employee by the employer because of the employee's involuntary separation from employment (regardless of whether such separation is temporary) resulting directly from a reduction in force, the discontinuance of a plant or operation or other similar condition.  Employers may want to consider filing a protective refund claim for FICA payments made on SUB pay in open tax years (generally 2006 or later).  Refund claims for FICA payments made during the 2006 calendar year are generally due by April 15, 2010. 


FICA taxes are imposed on a percentage of the "wages" that an employer pays to an employee.  Subject to certain exceptions, for FICA purposes, the term "wages" generally means all remuneration for any service performed by an employee for his or her employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash.  Unlike the federal income tax withholding rules, the FICA statute does not contain a specific provision addressing the treatment of SUB pay.

From 1956 to 1990, the Internal Revenue Service generally took the position that SUB pay was not "wages" subject to FICA taxation.  In 1990, the IRS issued Revenue Ruling 90-72 in which it reversed course, holding that SUB pay would be considered "wages" subject to FICA taxation unless it met a number of requirements, such as being linked to the receipt of state unemployment compensation benefits and not being paid as a lump sum. 

United States v. Quality Stores, Inc.

In United States v. Quality Stores, Inc. No. 1:09-cv-44 (W.D. Mich. Feb. 23, 2010), the taxpayer argued that SUB pay should not be considered "wages" for FICA taxation purposes because such pay is not remuneration for services performed by an employee.  The court agreed with the taxpayer and reasoned that FICA tax is imposed on remuneration for services to accomplish the remedial purpose of the Social Security Act.  When severance payments serve the same purpose as social security benefits (i.e., wage-replacement benefits for unemployed workers), the collection of FICA tax makes little sense.  The court concluded that the amounts of SUB pay at issue were properly viewed as wage-replacement social benefits, not taxable remuneration for employee services or wages, and thus such payments should not constitute "wages" subject to FICA taxation.

Practical Tips

  • Consider whether to file protective refund claims by April 15, 2010.  As an initial step, employers should determine if any FICA taxes have been paid on SUB pay during open tax years (generally 2006 or later) and whether to file a protective refund claim.  Refund claims for FICA payments made on SUB pay during the 2006 calendar year are generally due by April 15, 2010. 
  • Likely IRS Response.  The decision by the federal district court in Michigan is not controlling outside its district in Michigan and directly conflicts with a decision by the Federal Circuit Court of Appeals.  We anticipate that the Internal Revenue Service will appeal the decision and deny refund claims filed in response to the decision.  Employers may appeal denials to federal district court.
  • Looking Forward.  Employers should determine whether to file protective refund claims for open tax years after 2006.  Employers should also consider reviewing severance pay arrangements to determine whether such arrangements can be structured in the future to meet the IRS's current administrative requirements for exempting SUB pay from FICA taxation.  

Additional Information

This Update provides only a general summary of the federal district court decision.  For more information, please contact an attorney in our Employee Benefits & Executive Compensation or Federal Tax Practices.  You can find discussions of other recent cases, laws, regulations and rule proposals of interest on our website.