Tax Blawg

By Phil Karter

The Quality Stores employment tax refund case was argued before the Supreme Court on January 14, 2014.  An explanation about the issue at stake can be found in prior Taxblawg.net postings.  Although the outcome of the case remains in doubt, the possibility of a taxpayer victory means that employers should start thinking about the need to satisfy an important prerequisite to qualify their claims for refund.

Employment (FICA) taxes have both an employer and an employee component. A taxpayer victory in Quality Stores will enable both employers and terminated employees to recover their respective shares of FICA taxes withheld from the employees’ severance pay.  The obvious question that is likely to arise from an employer’s standpoint is “what incentive do I have to file on behalf of former employees?”

The answer can be found in Treasury Regulation § 31.6402(a)-2(a)(1)(ii), which stipulates that the employer will not be allowed a refund or credit for the employer’s share of withheld taxes “unless the employer has first repaid or reimbursed its employee or has secured the employee’s consent to the allowance of the claim for refund and includes a claim for the refund of such employee tax.”  In other words, merely notifying ex-employees of their rights to claim refunds themselves is inadequate to perfect the employer’s claim to recover its own share of withheld employment taxes. The employer must take affirmative steps on behalf of the terminated employee.

Thankfully, despite the above language about securing consents, the regulation elaborates that the requirement “does not apply to the extent that the taxes were not withheld from the employee or, after the employer makes reasonable efforts to repay or reimburse the employee or secure the employee’s consent, the employer cannot locate the employee or the employee will not provide consent.  Therefore, it is the attempt to secure consents that counts rather than the actual ability to secure such consents. (This same consent procedure also applies to employment tax refund claims arising from the Supreme Court’s ruling in United States v. Windsor, wherein the court struck down the Defense of Marriage Act (DOMA) as unconstitutional.  Prior to that decision, employers were required to withhold and pay over employment taxes for benefits provided to same-sex spouses of employees.)

Up to this point, a majority of employers that have filed protective refund claims have likely not undertaken the effort to obtain employee consents. There are at least two practical reasons for this.  First, the Sixth Circuit’s 2012 favorable decision in Quality Stores came out only about six months before the expiration of the 2009 statute of limitations (assuming the employer’s return was filed without extension). Thus, for employers eligible for refunds of FICA withholding paid over in that year, there wasn’t a good deal of time to accomplish this task.  Without a full solicitation of consents and tabulation of the refunds owed to employees who had responded affirmatively, there would have been no way to calculate the aggregate employee refund and include it on a refund claim.

Additionally, with the final outcome of Quality Stores, and the consequent entitlement to FICA refunds in doubt, it would have been hard for employers to justify the expense of undertaking the consent process when it wasn’t clear the exercise would be worthwhile when all was said and done.

Assuming the Supreme Court affirms Quality Stores, the simple solution for employers that filed protective claims covering only their share of FICA withholding is to file amended claims to add the aggregate employees’ share for those employees who provide their consents.  The procedure for this is set forth right in the instructions for Form 941-X on which the refund claim is made.  The instructions provide, in pertinent part, as follows:

5b.     . . . In certain situations, you may not have repaid or reimbursed your employees or obtained their consents prior to filing a claim, such as in cases where the period of limitations on credit or refund is about to expire. In those situations, file Form 941-X, but do not check a box on line 5. Tell us on line 25 that you have not repaid or reimbursed employees or obtained consents. However, you must certify that you have repaid or reimbursed your employees or obtained consents before the IRS can grant the claim.

 5c.     Check the box on line 5c to certify that your overreported tax is only for the employer share of social security and Medicare taxes. Affected employees did not give you consent to file a claim for refund for the employee share of social security and Medicare taxes, they could not be found, or would not (or could not) give you a statement described on line 5b.

 5d.     Check the box on line 5d to certify that your overreported amount is only for federal income tax, social security tax, Medicare tax, or Additional Medicare Tax that you did not withhold from your employees.

The Form 941-X instructions also provide a sample consent that can be used as a template by employers:

Employee name ____________________

Employer name  ____________________

I give my consent to have my employer (named above) file a claim on my behalf with the IRS requesting $_________ in overcollected social security and Medicare taxes for 20___. I have not claimed a refund of or credit for the overcollected taxes from the IRS, or if I did, that claim has been rejected; and I will not claim a refund or a credit of the amount.

 Employee signature _____________________

Date _________________

The consents are not sent to the IRS but retained by the employer. However, employers should be mindful not only to retain such consents, but also to adequately document their efforts to obtain consents for all qualifying employees, whether or not they are returned.

On a going-forward basis until Quality Stores is decided, employers can ease the burden of having to track down former employees and send out consent forms to qualify their own refund claims by incorporating a consent form along the lines of the template shown above into the paperwork typically involved in the termination process.  Of course, if Quality Stores is decided favorably, employers from that point forward will no longer be obliged to withhold, obviating the need to continue this practice.