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GT Alert

Possible Refund Opportunities for FICA Taxes Paid on Certain Termination Payments

April 2002
By Stuart Anolik, Craig A. Etter and Timothy J. Jessell, GT Tysons Corner

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On April 1, 2002 the Federal Claims Court issued a decision in CSX Corporation, Inc., v. The United States, holding that payments made pursuant to a company’s reduction in force to employees that have been involuntarily terminated constitute supplemental unemployment compensation and thus are not "wages" for purposes of FICA. The IRS has 60 days from the date of the judgment to decide whether it will appeal this decision.

"...payments made pursuant to a company’s reduction in force to employees that have been involuntarily terminated constitute supplemental unemployment compensation and thus are not "wages" for purposes of FICA."

The Opportunity. Companies that have engaged in substantial employee terminations over the past couple of years should consider the impact of the CSX decision, especially if the company is running up against the limitations period to obtain a refund1.  These companies may consider filing a "protective" claim for refund of FICA taxes paid on qualifying termination payments.

To fit within the CSX case parameters, a company’s payments to terminated employees must:

  • be pursuant to a plan for a reduction in force; and
  • paid to employees who have been involuntarily separated from employment.

The CSX case does not cite any specific definitions of what constitutes a "plan" or a "reduction in force." Also, as will be discussed below, the case makes it clear that payments to employees who have been terminated but are required to continue to provide service to the employer to obtain payments are "wages" and thus subject to FICA withholding tax.

The Case. CSX implemented major reductions in workforce through the following categories of actions:

  • Category 1- job layoffs;
  • Category 2- reductions in hours of work and rates of pay; and
  • Category 3- permanent separations from employment.

CSX paid the employer’s share of employment tax and withheld and remitted the employee’s share on the termination payments. Following those payments, CSX filed timely claims for refund on their own behalf and on behalf of various employees.

The Holding. The Federal Claims Court held that certain of the CSX termination payments constituted supplemental unemployment compensation under section 3402(o) of the Code2.  Supplemental unemployment compensation benefits are defined as:

[A]mounts 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 Court held that "the fundamental definition of wages under FICA and income tax withholding statutes are to be understood as identical." Thus, the income tax withholding definition of "wages" was used to determine whether the termination payments at issue constituted "wages" for FICA purposes.

Applying the definition of supplemental unemployment compensation to the three categories of payments made by CSX, the Court held:

  • Category 1 employees-laid off. Since these employees were no longer performing any services for the employer, such employees had undergone a "separation from employment" within the meaning of § 3402(o) and thus the supplemental unemployment compensation were not "wages" for FICA purposes.
  • Category 2 employees-reductions in hours of work and rates of pay. Since these employees were subject to recall on an as-needed basis and remained on the railroad’s active service payroll and were guaranteed a certain minimum compensation per pay period adjusted by amounts paid for work actually performed, while they may have been underemployed, they were not unemployed. Accordingly, there was no "separation from employment" within the meaning of § 3402(o)(2) and thus these payments were "wages" for FICA purposes.
  • Category 3 employees-permanent separation from employment. These employees were offered the option of terminating their employment relationship with the company (and simultaneously relinquishing all rights and benefits) in exchange for a separation payment. There were two sub-groups.
    1. An employee who elects a separation payment in lieu of layoff benefits has permanently relinquished his or her status as an employee after having been involuntarily separated from employment. Thus, termination payments constituted supplemental unemployment compensation and were not "wages" for FICA purposes.
    2. An employee who elects separation in lieu of remaining in their existing positions (including those employees who elect separation in lieu of standby), have not been involuntarily separated. Thus, payments to these employees were "wages" for FICA purposes.



1 Section 6511 of the Internal Revenue Code of 1986, as amended, (the "Code") provides a claim for refund on overpayment of FICA taxes must be filed within 3 years from the date the return was filed or 2 years from the time the tax was paid, whichever is later.

2 Section 3402 (o) is part of the income tax withholding provisions of the Code.


© 2002 Greenberg Traurig

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