Potential refund of payroll taxes on severance pay.

Employers who paid payroll taxes on terminated employees' severance pay may be entitled to a refund. In CSX Corp., Inc., 52 Fed. Cl.208 (2002), the Court of Federal Claims approved the refund of Railroad Retirement Tax Act (RRTA) taxes and FICA collected on amounts paid to employees under reduction-in-force programs.

The court addressed whether CSX'S payments fell outside the definition of "wages" for FICA purposes and the definition of "compensation" for RRTA purposes. It considered three types of severance payments, made to:

1. Laid-off employees;

2. Employees on stand-by (i.e., reduced hours); and

3. Employees who voluntarily participated in an early-retirement or early-out program.

The court determined whether these payments fit within the definition of "supplemental unemployment compensation benefits" (SUCBs) as used in Sec. 3402(o). If the payments fit, they were not subject to FICA taxation, nor to income tax withholding. Sec. 3402(o)(2 (A) defines SUCBs 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 [referring to a discontinuance in the performance of service by the employee for 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, but only to the extent such benefits are includible in the employee's gross income.

For payments made to workers involuntarily terminated, the court concluded that the laid-off employees were not performing any service for the employer. Thus, these payments qualified as SUCBs, not subject to payroll taxes.

The court determined that payments made to employees on stand-by, who remained subject to recall on an as-needed basis and who received a guaranteed minimum compensation per pay period, were subject to tax, because there was no separation from employment within the meaning of Sec. 3402(o)(2); thus, these employees were not unemployed.

Finally, for payments made to employees who volunteered for "early retirement," it found that the voluntary surrender of employment rights for a cash payment represented the surrender of rights to future earnings for a present sum. Thus, these amounts were wages subject to payroll tax.

The IRS will probably suspend applications for refunds, pending a decision on whether to appeal CSX.

FROM RODNEY M.JONES, WASHINGTON, DC