A circuit court has ruled that severance payments given to employees are not taxable, a decision that could have far-reaching implications.

In U.S. v. Quality Stores Inc., the Sixth Circuit held that payments made by a company to employees as part of the company’s severance program were not subject to tax under the Federal Insurance Contributions Act.

The ruling, made on Sept. 7, 2012, upheld both the bankruptcy court and the district court, and rejected a 2008 ruling by the Federal Circuit in CSX v. U.S. that found the payments were dismissal pay, subject to tax.

The decision could have national implications, according to KPMG tax professionals, who advised companies throughout the country to examine potential tax technical and business ramifications.

“Although this decision is currently most pertinent to companies with their 'principal place of business' in the Sixth Circuit states of Michigan, Kentucky, Ohio and Tennessee, future Internal Revenue Service or court activity could expand the geographic reach, and therefore employers based outside the Sixth Circuit should also take notice," said Scott Schapiro, a tax principal in KPMG’s International Executive Services practice, who participated in a webcast sponsored by the U.S. audit, tax and advisory firm.

"While these conflicting decisions leave employers with a less than certain national response, the Quality Stores ruling could open an opportunity for employers with their 'principal place of business' in the Sixth Circuit for potential refund and/or prospective savings opportunities," Schapiro said.

Schapiro and other KPMG professionals on the webcast explained that, ultimately, the ability of employers to rely on the Quality Stores decision, prospectively and for refund purposes, will depend on several factors that take into account geography, specific terms of severance payments made and, in the case of refunds, future IRS or court action on the issue.

They also pointed out that if a company has made past severance payments or anticipates future severance payments as a result of closures, reductions in force, and other similar actions, the FICA tax treatment of such severance payments may also be worth analyzing.

The U.S. government has until Oct. 22, 2012 to request a rehearing in the Sixth Circuit case. Assuming a petition for rehearing is not filed and/or allowed, the government has until Dec. 6, 2012, to file a certiorari petition with the U.S. Supreme Court.

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