Government Prevails in Quality Stores

The Supreme Court today ruled 8-0 in favor of the government in the long-running Quality Stores litigation, holding that severance payments are taxable FICA wages, even if they fall within the category of “supplemental unemployment compensation benefits” that are subject to income tax withholding under Code section 3402(o).  See our prior coverage here.  The Court’s opinion closely tracks the arguments made by the government in its brief.

The Court began by analyzing the definition of “wages” in the FICA statute, which it repeatedly characterizes as “broad.”  That definition — “remuneration for employment” — appears to encompass the payments at issue because “common sense dictates that the employees receive the payments ‘for employment.'”  Specifically, they are paid only to employees and often vary according to the function and seniority of the particular employee who is terminated.  The Court buttressed this statutory interpretation by pointing both to other aspects of the statutory definition and to its history.  In particular, the Court noted that Code section 3121(a)(13(A) exempts severance payments made because of “retirement for disability” and that exception would appear superfluous if “wages” did not generally encompass severance payments.  The Court also observed that in 1950 Congress had repealed a statutory exception for “dismissal payments,” thus suggesting that severance payments are not meant to be excepted from FICA “wages.”

The Court then turned to responding to the taxpayer’s argument that a contrary inference must be drawn from the treatment of SUB payments in the income tax withholding statute — specifically, that section 3402(o) directs that income tax should be withheld from such payments “as if” they were wages, which indicates that they are not in fact “wages.”  The Court found this provision “in all respects consistent with the proposition that at least some severance payments are wages,” citing to the Federal Circuit’s analysis of the textual issue in the CSX case.  The Court did not reject out-of-hand the taxpayer’s reliance on the heading of section 3402(o), which refers to “certain payments other than wages,” but said that the heading “falls short of a declaration that all the payments listed in section 3402(o) are not wages.”

The Court then embarked on a detailed discussion of the regulatory background against which section 3402(o) was enacted in order to demonstrate why it should not be understood as reflecting a Congressional determination that SUB payments are not FICA “wages,” despite the contrary inference that might logically be drawn from its text standing alone.  Briefly, the Court explained that Congress was solely focused on solving a withholding conundrum created by the regulatory treatment of SUB payments when SUB plans proliferated in the 1950s.  The IRS sought to impose income tax on these payments, but it did not want to characterize them as “wages” because that would have caused state unemployment benefit payments to stop in some cases (because some states would not pay unemployment compensation to people receiving “wages”).  As a result, some individuals were being hit with big tax bills at the end of the year.  Congress wanted to implement withholding for such payments and crafted section 3402(o) broadly so as to cover a spectrum of payments without regard to whether they qualified as FICA “wages.”  Accordingly, the Court concluded that section 3402(o) sheds no light on the definition of FICA “wages.”

The Court added that its approach is consistent with its 1981 decision in Rowan, which had been invoked to support the taxpayer’s position.  The Court stated that the government’s position, not the taxpayer’s, best advanced “the major principle recognized in Rowan:  that simplicity of administration and consistency of statutory interpretation instruct that the meaning of ‘wages’ should be in general the same for income-tax withholding and for FICA calculations.”

Finally, the Court stated that it would not address the validity of the IRS’s currently applicable revenue rulings that exempt from both income-tax withholding and FICA taxation severance payments that are tied to the receipt of state unemployment benefits.  As discussed in our report on the oral argument in this case, the government was questioned repeatedly about these rulings because they are hard to square with the broad reading of the FICA “wages” definition advanced by the government here and now adopted by the Court.  Those rulings are more generous to taxpayers than would appear to be required under the broad FICA definition.  It remains to be seen whether the IRS will revoke those rulings and try to collect FICA taxes on such payments and, if they do, whether that will have an effect on the payment of state unemployment benefits.  With the Court having refrained from invalidating, or even directly criticizing, those rulings, it is possible that the IRS will let sleeping dogs lie and continue to abide by the rulings.

Quality Stores – Supreme Court opinion

Supreme Court Hears Oral Argument in Quality Stores

The Supreme Court heard oral argument on January 14 in Quality Stores.  Whether it was because of a lack of interest in the subject matter or because it was the third argument of the day at the unusually late hour of 1:00 (the Court’s usual schedule in recent years calls for two (sometimes only one) arguments in the morning that finish before lunch), the Court was less active than usual in its questioning.  Indeed, the government’s counsel began to sit down after using only five of his allotted 30 minutes for his opening argument (though he was then persuaded to remain at the podium by some additional questions).  By the end, all of the Justices except Justice Thomas participated, and the advocates for each side had to deal with some hostile questions.  The questioning was not so one-sided as to make the outcome a foregone conclusion, but the Court seemed to be leaning more towards the government’s position than the taxpayer’s.  On the other hand, the Court seemed to be learning some of the nuances of the case as the argument proceeded, so there is the possibility that the views of some Justices could yet shift from where they appeared to be at oral argument.

Eric Feigin began the argument for the government, and he was allowed to make his basic presentation without interruption – namely, that the severance pay here comes within the broad definition of FICA wages and the Court should not have to worry about the text of section 3402(o), the income tax withholding statute on which the taxpayer relies.  On the latter point, Justice Ginsburg interrupted to ask about the statement in Rowan indicating that wages should be interpreted the same way for FICA and income tax withholding.  Mr. Feigin gave two responses:  1) Rowan does not say that the income tax statute should govern the substance of the FICA statute; and 2) the basic principle of Rowan is to establish congruence between FICA “wages” and income tax withholding “wages” for purposes of administrability, and that goal would be advanced by adopting the government’s position.

After Mr. Feigin described the background of the 1969 income tax withholding legislation, Justice Kennedy asked about the history of FICA withholding of supplemental unemployment benefits.  Mr. Feigin responded that there is no FICA withholding of SUB payments, apparently referring to the government’s narrow definition of SUB payments that the revenue rulings exempt from FICA wages, rather than the broader concept of SUB payments as defined in section 3402(o).  The Chief Justice then asked him to clarify the reason for the enactment of section 3402(o), and Mr. Feigin explained that the benefits were considered to be taxable income even if not subject to withholding.  At that point, Mr. Feigin stated that he was prepared to sit down unless there were further questions.  That suggestion proved to be premature, as it turned out that there were several Justices who still had questions.

Justice Ginsburg began by asking about the effect on state unemployment compensation.  That question arises from the fact that some states will not pay unemployment compensation if the employee is receiving “wages,” even if the employee is out of work.  To avoid having individuals in those states lose their state unemployment benefits as a result of receiving SUB payments from their employer, the IRS has drawn a strange distinction in its revenue rulings, currently providing that SUB payments must be “linked to state unemployment compensation in order to be excluded from the definition” of FICA wages.  Rev. Rul. 90-72.  That distinction is policy-driven, but makes no logical sense as an interpretation of the statutory text.  Mr. Feigin sought at first to steer away from this problem by saying that the government was arguing for the status quo, so nothing would change.  He added, however, that “if the court were to reach some other conclusion in this case than the one the government is urging” (which appears to be a reference to the possibility that the Court’s decision would wipe out the distinction in the revenue ruling), then that might have an effect on state unemployment benefits.  The states, he argued, could then cure any problems by amending state law.

After a short response to Justice Kennedy’s question about whether some employees might prefer to have these payments treated as FICA wages, Mr. Feigin again began to sit down.  This time Justice Alito asked whether it would make a difference if the payments were not keyed to length of service.  Mr. Feigin responded that the government’s position would be the same.  Justice Alito then followed up by citing the Coffy case and asking why the distinction drawn there “between compensation for services and payments that are contingent on the employee’s being thrown out of work” was not applicable.  Mr. Feigin replied that the cases involved different issues and different definitions.  He went on to argue that FICA does not distinguish “between payments that are part of the continuing employment and payments that occur at the end of the employment relationship,” stating that FICA wages include retirement pay and dismissal payments.  At that point, Mr. Feigin again offered to end his presentation and was permitted to sit down after 12 minutes of argument.

Robert Hertzberg argued for the taxpayer and began by arguing that the SUB payments were not “remuneration for services” – and hence not FICA wages – because, as stated in Coffy, they were contingent on losing one’s job.  Justice Sotomayor asked the first question, inquiring whether the taxpayer could prevail if the Court invalidated the government’s “regulation” (likely a reference to the applicable IRS revenue rulings).  This question appears to have been prompted by the heavy criticism of the IRS rulings, particularly in the amicus briefs, with Justice Sotomayor wanting to put aside the rulings and focus on the statute.  Mr. Hertzberg replied that the taxpayer should prevail because the statutory language is clear, and the FICA and income tax withholding statutes should have the same meaning under Rowan.  Both Justices Sotomayor and Ginsburg then suggested that it would be simpler and more appropriate to have the SUB payments treated the same way under the two statutes.  Mr. Hertzberg replied that they were not “wages” under the statute.  He added that different treatment made sense because the SUB payments are provided as a “safety net” and logically ought not to be reduced by FICA taxation in order to fund Medicare and Social Security.

Justice Scalia pointed out that the payments are “for faithful and good past services” because they are paid only to employees, and this comment led to a bevy of questions from all sides.  Justice Ginsburg remarked that there “are some severance payments that do count for FICA purposes,” even under the taxpayer’s position.  Justice Alito asked what would happen if section 3402(o) did not exist.  Mr. Hertzberg replied that the term “supplemental unemployment benefits” has its own definition, going back to 1960 legislation dealing with trusts, and those benefits have not been regarded as FICA wages, even in the 1977 revenue ruling.  He then emphasized that Congress reenacted the FICA statute in 1986 against that backdrop, and therefore that payments falling within the existing definition of SUB payments should not be within FICA wages.

Justice Breyer then objected that the FICA definition is very broad.  With respect to income tax withholding, he questioned whether section 3402(o) shouldn’t be viewed as just being enacted to be on the safe side, but not necessarily indicating that Congress had concluded that SUB payments were not FICA wages.  Mr. Hertzberg responded that it was clear from the text, the title of the section, and the legislative history that Congress did not understand SUB payments to fall within FICA wages.  This triggered Justice Ginsburg to ask again what is the distinction between “dismissal payments” that are subject to FICA and those that are not.  After Mr. Hertzberg described that distinction (that SUB payments must come from a plan and follow a mass layoff or plant closing), Justice Breyer came back to his question.  Acknowledging now that Congress in 1969 probably did not view the SUB payments as FICA wages when it passed section 3402(o), he asked why that should be given weight in construing the FICA statute passed earlier by a different Congress.  Mr. Hertzberg replied that the statutes were reenacted together in 1986, and therefore it was not just a matter of a later Congress commenting on what an earlier Congress had passed.  Justice Breyer’s followup comment, however, indicated that he either did not understand or was not persuaded by this answer, as he noted that the statute was passed because there was “authority saying it wasn’t wages,” but the authority was not necessarily correct.

Justice Alito then asked about the government’s argument that the “treated as” language in section 3402(o) was necessary because the IRS had ruled that some SUB payments are not wages, but it did not mean that all such payments were not wages.  Mr. Hertzberg replied that the language of 3402(o) was clear, particularly the title, which addresses payments “other than wages.”  The argument closed with Justice Scalia promising to ask the government on rebuttal about Mr. Hertzberg’s point that, given the reenactment of both statutes at the same time, it appeared that section 3402(o) is superfluous under the government’s position.

Mr. Feigin begin his rebuttal by addressing Justice Sotomayor’s question about how the Court should approach the case if the IRS revenue rulings are invalid.  He said that this would not affect the outcome of this case because the defect in the rulings would be that they exclude some SUB payments from wages, when in fact all such payments should be included.  That is, any problem would be cured by making even more SUB payments subject to FICA taxation.  Justice Sotomayor replied that this answer was “touching at what I was thinking,” and then asked Mr. Feigin to address Justice Scalia’s point about 3402(o) being superfluous.  Mr. Feigin began by acknowledging that “the revenue rulings are not consistent with the statutory text of FICA.”  He attributed this defect to the fact that the rulings trace back to a “more freewheeling time in the history of statutory interpretation.”

Justice Scalia then jumped in to bring the discussion back to whether section 3402(o) was unnecessary, stating that the statute “contradicted itself” if the government’s position were correct.  Mr. Feigin responded by making the same point that Justice Alito had made earlier (also reflected in the Federal Circuit’s CSX decision) that there was no contradiction if section 3402(o) was drafted as it was because there were some SUB payments that were not wages under the revenue ruling.  Justice Scalia found that response unsatisfying since the title clearly refers to payments “other than wages.”  Mr. Feigin answered by saying that the title refers to “certain payments” and the statute provides that they should be “treated as wages for a payroll period.”  He then went on to reiterate his prior points about the history of the development of section 3402(o) and argued that it was drafted as it was to cover the possibility that the IRS would draw different distinctions in the future regarding which SUB payments constitute “wages.”

Finally, this discussion prompted Justice Ginsburg and Chief Justice Roberts to revisit the IRS revenue rulings, which the Chief Justice characterized as taking a narrower view of the FICA definition than the government was arguing for.  Mr. Feigin responded that the rulings were not directly at issue here, but if the Court thought it had to rule on them, it should follow the government’s current arguments regarding the statutory text “notwithstanding the revenue rulings.”  He then again assured Justice Ginsburg that the states could fix any bad results related to their own unemployment compensation schemes that might ensue from invalidating the revenue rulings.

It is always tricky to forecast a Supreme Court decision based on the oral argument.  Still, it cannot have been encouraging for the taxpayer that its counsel was the recipient of most of the difficult questioning, with Justices Sotomayor and Breyer in particular seeming to exhibit agreement with the government’s position.  On the other hand, as noted above, the Court appeared still to be digesting some of the complexities of this case, so the positions reflected at oral argument are not set in stone.  For example, Justice Scalia showed more skepticism of the government’s position during rebuttal than he did during Mr. Feigin’s opening argument.  Time will tell.  A decision is expected this spring, likely issuing sometime between late March and early June.  If the vote on the Court is 4-4, however (with Justice Kagan being recused), then the Court will announce that outcome as early as next week.  That is because there will be no need to write an opinion; the result will just be a one-line announcement that the decision has been affirmed by an equally divided Court.

Taxpayer Brief Filed in Quality Stores

The taxpayer has filed its responsive brief in Quality Stores, setting forth both its basic position that SUB payments are not FICA “wages” and responding in detail to the government’s contrary arguments.  The taxpayer’s affirmative case begins with the income tax withholding provisions that the government has argued are irrelevant.  The taxpayer argues that the payments are not “remuneration . . . for services” within the meaning of Code section 3401(a) and, in particular, cannot be “wages” because they fall within the category of payments that section 3402(o) describes in its title as “certain payments other than wages” and in the text provides that they “shall be treated as if [they] were a payment of wages.”  That statutory argument is supplemented by examination of the legislative history of the passage of section 3402(o) and by a detailed parsing of other statutory provisions suggesting that Congress did not regard these payments as “wages.”  The taxpayer also points to statements made by the Court about SUB benefits in another context in Coffy v. Republic Steel Corp., 447 U.S. 191 (1980), to the effect that such payments are not “compensation for work performed” because “they are contingent on the employees being thrown out of work.”

The brief also responds to the arguments made by the government.  It dismisses the broad definition of FICA wages in Social Security Bd. v. Nierotko, 327 U.S. 358 (1946) — made in the context of back pay to a current employee — as not probative here where the recipient is not in a current employment relationship with the employer.  The taxpayer also takes issue with the government’s reliance on the historical treatment of “dismissal payments,” arguing that these payments are not synonymous with SUB payments.

The taxpayer invokes the Court’s Rowan decision in support of its basic position that “wages” must be construed the same for both FICA purposes and income tax withholding purposes.  As noted in our previous report, the government has chosen to oppose this argument without relying on the so-called “decoupling amendment” that Congress enacted in the wake of Rowan.  The taxpayer disputes the government’s argument that the consistency rationale of Rowan is best served by treating SUB payments as “wages” for both purposes.  To the contrary, the taxpayer argues, there is a sound policy reason for treating such payments as “wages” for income tax withholding (preventing a heavy year-end tax burden), but no corresponding policy reason to do so in the FICA context.

The taxpayer’s brief devotes considerable attention to arguing that no deference should be paid to the IRS’s Revenue Rulings defining what kind of severance payments constitute “wages.”  This topic is also the focus of an amicus brief filed by Professor Kristin Hickman, which asks the Court to hold that such rulings are not entitled to Chevron deference because they are not promulgated in compliance with the Administrative Procedure Act.  This focus is a bit surprising since the government’s brief does not argue for deference to its Revenue Rulings, and government officials have previously publicly stated that the Justice Department will no longer argue in court that Revenue Rulings are entitled to Chevron deference.   The government’s brief, however, does discuss its relevant Revenue Rulings in some detail, in the nature of background for why it believes Congress addressed income tax withholding in the way that it did.  The taxpayer treats this discussion as reflecting an “implicit (and incorrect) presumption” that the Court must defer to the Revenue Rulings and, taking no chances, the taxpayer tackles that presumption head-on.

Oral argument is scheduled for January 14.

Quality Stores – Taxpayer’s Response Brief

Quality Stores – Amicus Brief of Prof. Hickman

 

Supreme Court Briefing Underway in Quality Stores

The government has filed its opening brief in the Quality Stores case, which involves the question whether severance payments made pursuant to an involuntary reduction in force are subject to FICA taxation.  See our prior coverage here. The brief is considerably shorter than the page limit, as the government has sought to take a relatively simple approach to an issue that in the past has generated complex and detailed briefs and opinions.

The government’s primary submission is that the Court needs to focus its attention on the FICA statute and not be distracted by the income tax withholding statute that formed the basis for the Sixth Circuit’s opinion.  The FICA statute broadly defines “wages” for FICA purposes as “remuneration for employment,” and that language assertedly encompasses the severance payments at issue here.  To support the argument that this language should be read broadly, the government points to current Treasury regulations and to the Supreme Court’s decision in Social Security Board v. Nierotko, 327 U.S. 358 (1946).  The government also relies on the history of the FICA definition of wages, pointing out that it originally contained an exception for discretionary “dismissal payments” like those at issue here, but that exception was repealed in 1950.

The brief then moves on to respond directly to the Sixth Circuit’s reliance on 26 U.S.C. 3402(o), the income tax withholding provision stating that severance payments should be “treated as . . . wages” (and therefore, according to the taxpayer, must be something different from “wages.”)  The government states that, by its terms, this provision applies only to income tax withholding and can provide no inference for determining whether the severance payments are subject to FICA taxation.  Even if that basic point does not prevail, however, the government argues that the inference drawn by the Sixth Circuit is incorrect.  Adopting the analysis of the Federal Circuit in CSX, the government argues that the term “wages” and the class of payments included in section 3402(o) are not mutually exclusive; the latter section is broadly drafted and can encompass payments that also fall within the category of “wages.”  The brief then embarks on a fairly detailed account of the history of the IRS’s administrative rulings on the scope of “wages,” seeking to explain why Congress was motivated to enact section 3402(o) as it did and, correspondingly, why that action should not carry any logical inference for the definition of FICA wages.  In particular, the government argues that Congress was concerned that the IRS had determined that certain payments were includible in gross income, but not subject to income tax withholding, thus leaving taxpayers with an unexpectedly high tax bill when it came time to file their return.  In acting to solve that problem, the government maintains, Congress was not saying anything about FICA nor was it defining “wages” even for income tax withholding purposes.

For those that have followed this issue over the years, we note one subissue that has receded in importance under the government’s current approach — namely, the relevance of legislation enacted by Congress in the wake of the Court’s decision in Rowan Cos. v. United States, 452 U.S. 247 (1981).  Taxpayers have pointed to Rowan as indicating that terms in the FICA statute and income tax withholding statute generally ought to be interpreted harmoniously.  In the Sixth Circuit and in other litigation, the government has defended against the citation of Rowan by pointing to later legislation in which Congress codified the specific result in Rowan but also enacted a “decoupling amendment” establishing that nothing in the income tax withholding regulations providing an exclusion from “wages” “shall be construed to require a similar exclusion from ‘wages'” in the FICA regulations.  31 U.S.C. § 3121(a).  The legislative history described this provision as broadly decoupling the FICA definition of wages from the income tax withholding definition.   See our reports on the Sixth Circuit briefing here and here.  The Sixth Circuit, however, was unpersuaded by the “decoupling amendment” argument because applying decoupling to statutory definitions of “wages” is based entirely on the legislative history; the decoupling amendment itself expressly addresses only regulations.  The Federal Circuit in CSX similarly rejected the government’s position on the decoupling amendment, even though it agreed with the government on the ultimate issue of including severance pay in FICA wages.

The government apparently has concluded that the “decoupling” argument will fare no better in the Supreme Court.  Instead, it makes other arguments to defend against the taxpayer’s reliance on Rowan.  First, it argues simply that Rowan is irrelevant because it was addressing a different issue — the validity of a Treasury regulation providing that the value of meals and lodging should be included in FICA wages.  More substantively, the government argues that its position is consistent with the rationale of Rowan.  The Court stated there that Congress intended to coordinate the FICA and income tax withholding systems to advance Congress’s interest in “simplicity and ease of administration” (452 U.S. at 257).  According to the government, that interest is disserved by the Sixth Circuit’s decision because Congress has provided that the supplemental benefits included in the section 3402(o) definition are to be treated as wages for income tax withholding purposes.

The taxpayer’s response brief is due in mid-December, and oral argument is scheduled for January 14.

Quality Stores – Opening Brief for the Government

Petition for Certiorari Filed in Quality Stores

The government has finally filed its long-awaited cert petition in Quality Stores, asking the Supreme Court to review the Sixth Circuit’s ruling that severance payments paid to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes.  In our previous coverage, we have noted why this case is a strong candidate for Supreme Court review, and the cert petition sets those forth succinctly:  (1) “the Sixth Circuit’s decision in this case squarely conflicts with the Federal Circuit’s decision in CSX Corp.”; and (2) “the question presented here is both recurring and important.”  The petition elaborates on that latter point by stating that the question presented “is currently pending in eleven cases and more than 2400 administrative refund claims, with a total amount at stake of more than $1 billion.  That figure is expected to grow.”

The petition goes on to address the merits of the underlying issue in some detail, even though there will be another opportunity to brief the merits if certiorari is granted.  In essence, the government argues that the court of appeals went astray by drawing an inference about FICA taxation from Code section 3402(o)(2), which addresses income tax withholding.  The government asserts that the “court of appeals’ chain of reasoning reflects significant misunderstandings of Section 3402(o)’s text, history, and purpose.”  To the government, that section “simply directs that payments encompassed by the statutory definition will be subject to income-tax withholding whether or not they would otherwise be ‘wages.’”  Therefore, it “has no logical bearing on the determination whether particular payments to terminated employees are subject to FICA taxation.”

Instead, according to the government, the FICA taxation issue should be resolved simply by asking whether the severance payments were “wages.”  Looking to Social Security Board v. Nierotko, 327 U.S. 358 (1946), and other authorities, the government concludes that they are “wages” and therefore should be subject to FICA taxation.

The taxpayer’s response is currently due in early July.  Because of the Court’s summer recess, however, a decision on whether to grant certiorari will not be announced before late September.

Quality Stores – Petition.for Certiorari

Cert Petition in Quality Stores Now Due on May 3

The Supreme Court has granted the government’s request for a one-month extension to file its petition for certiorari in Quality Stores, extending the due date from April 4 to May 3.  As we have previously observed, we believe there is a strong likelihood that the government will petition in this case and that the Court will grant certiorari to resolve the circuit conflict on the treatment for FICA purposes of supplemental unemployment compensation benefits.  See our previous coverage here.

With this extension, however, the Court likely will not decide whether to grant certiorari until early October, after the summer recess.  If Quality Stores were to file its response to the cert petition early, however, without taking its full 30 days to respond, then the petition could still be ready for a ruling by the Court before the summer recess.  In either event, if the Court were to grant certiorari, the case would probably be argued in late 2013, with a decision on the merits expected by June 2014.

Rehearing Denied in Quality Stores

Acting promptly after receiving the taxpayer’s response, the Sixth Circuit has denied the government’s petition for rehearing en banc in Quality Stores.  Even though the government’s petition pointed to a direct circuit conflict and alleged tension with the Sixth Circuit’s own precedent (see our report here), the court’s order recites that no judge on the Sixth Circuit requested a vote on the petition.

The court’s order puts the ball back in the government’s court to decide whether to seek Supreme Court review.  Given the conflict and the apparent importance of having a uniform nationwide rule, there is a significant possibility that the government will ask the Supreme Court to step in.

A petition for certiorari would be due on April 4.

 

Taxpayer Responds to Petition for Rehearing in Quality Stores

Following up on the Sixth Circuit’s order, the taxpayer has now filed a response to the government’s petition for rehearing en banc in Quality Stores.  See our prior reports here.  The brief offers a point-by-point response to the government’s petition, arguing in particular that the Sixth Circuit was correct in relying on Coffy v. Republic Steel Corp., 447 U.S. 191 (1980), and disputing the government’s contention that the panel’s decision was inconsistent with earlier Sixth Circuit decisions.

The petition is now back in the lap of the Sixth Circuit, which could rule in the next few weeks on whether it will rehear the case.

Quality Stores – Taxpayer Response to Petition for Rehearing

 

 

Sixth Circuit Orders Response to Government’s En Banc Petition in Quality Stores

The Sixth Circuit yesterday directed the taxpayer to file a response to the government’s petition for rehearing en banc in Quality Stores.  As we previously noted, the Federal Rules of Appellate Procedure prohibit responding to rehearing petitions unless ordered by the court, but such an order in this case was a strong possibility.  Courts of appeals frequently direct responses to rehearing petitions filed by the government, and the government’s petition highlights why this case is a strong candidate for the relatively rare action of rehearing en banc.  If the court’s order is surprising at all, it is that it took so long to issue it.

The order signifies that the Sixth Circuit is giving more than usual attention to this rehearing petition, but it does not necessarily mean that the petition will be granted.

The taxpayer’s response is due December 18.

 

Government Seeks Rehearing En Banc in Quality Stores

The government yesterday filed a petition for rehearing en banc in the Sixth Circuit in the Quality Stores case, asking the full court to reverse the panel and eliminate the circuit conflict on the treatment for FICA purposes of supplemental unemployment compensation benefits.  As noted in our previous post, regardless of whether the petition is granted, the mere filing of the petition has the effect of postponing the deadline for seeking Supreme Court review.  The 90-day period for filing a petition for certiorari begins to run anew from the date of the resolution of the rehearing petition.  Thus, if this case ultimately goes to the Supreme Court, there is no longer any realistic possibility that it would be heard this Term — that is, a decision could not be expected by June 2013.

The rehearing petition emphasizes that the issue is important, stating that $120 million is at stake in pending refund suits alone, and that a total of over $1 billion is at issue when all claims are taken into account.  It also recites that the IRS has suspended action on administrative refund claims totalling over $127 million from approximately 800 taxpayers located in the Sixth Circuit.

The petition argues that the Sixth Circuit panel erred in two key respects.  “First, it failed to address the actual FICA question here based on its erroneous belief that Coffy [v. Republic Steel Co., 447 U.S. 191 (1980),] establishes that SUB pay is not wages for FICA purposes.”  Coffy was not a tax case, but instead was a case interpreting the Veterans’ Reemployment Rights Act, holding that SUB benefits are a “perquisite of seniority” for which returning veterans must be given service time credit for the time they spent in the military.  (That may sound deadly dull, but I note parenthetically that Coffy was also my first Supreme Court argument.)  On this point, the petition argues that the panel’s decision is in tension with two prior Sixth Circuit decisions holding that wages for FICA purposes is not limited to compensation for work performed.

The second error asserted in the rehearing petition is that, “in construing I.R.C. § 3402(o), the panel failed to recognize that the section’s applicability is expressly limited to income-tax withholding, which was a key factor in the Federal Circuit’s CSX decision.”  That issue was a focus of the original briefing in the case, but the rehearing petition asserts that the panel failed to address it in its decision.

There is no current due date for the taxpayer’s response.  Rule 40(a)(3) of the Federal Rules of Appellate Procedure provides that parties are not to respond to petitions for rehearing unless ordered by the court.  Given the importance and complexity of this case, there is a strong probability that the court will order a response.

Quality Stores – Petition for Rehearing

Sixth Circuit Creates Circuit Conflict on FICA Exclusion for Severance Payments

More than two years after the appellate briefing was completed, the Sixth Circuit has finally issued its decision in Quality Stores.  (See our previous coverage here.)  The court ruled that severance payments paid to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes.  In so holding, the Sixth Circuit expressly declined to follow the Federal Circuit’s contrary decision in CSX Corp. v. United States, 518 F.3d 1328 (2008).

The court agreed with the taxpayer’s argument that the severance payments are not literally “wages” under the Code.  Although Code section 3402(o) provides that “supplemental unemployment compensation benefits” (which the court found to include these severance payments) should be “treated . . . as wages” for income tax withholding purposes, there is no analogous directive for FICA.  At the same time, relying on Rowan Cos. v. United States, 452 U.S. 247 (1981), the court ruled that the definition of “wages” is the same for income tax withholding and FICA purposes.  (As discussed in prior posts, the government argues that intervening legislation has made Rowan no longer good law for that proposition.)  Therefore, the court concluded, the Code does not make the severance tax payments subject to FICA taxation.

The government is likely to seek further review in this case.  Given the clear circuit conflict, and the importance to the case of the continuing vitality of the Supreme Court’s decision in Rowan, this issue is certainly a candidate for Supreme Court review down the road.

A petition for rehearing is due on October 22.  A petition for certiorari is currently due on December 6.  That date would be pushed off if the government seeks rehearing.

Quality Stores – Sixth Circuit opinion

Oral Argument Scheduled in Quality Stores

At long last, the Sixth Circuit has scheduled oral argument in the Quality Stores case for October 6, 2011.  This will be more than a year since the briefing in the case was completed.  The identity of the three-judge panel is expected to be announced on September 19.

Supreme Court Opts for Chevron Analysis of Treasury Regulations, Discarding the Traditional National Muffler Dealers Analysis

The Supreme Court this morning issued its opinion in the Mayo Foundation case, ruling unanimously that medical residents are not “students” exempt from FICA taxation.  As previously discussed several times on this blog (see here, here, and here), the Mayo case carried the potential for broad ramifications beyond its specific context because the parties had framed the question of whether deference to Treasury regulations is governed solely by general Chevron principles that supersede the deference analysis previously developed in tax cases like National Muffler Dealers.  The Court in fact addressed that question and has now endorsed use of the Chevron standard in tax cases, thereby providing the IRS with a big victory that will make it more difficult for taxpayers to prevail in court in the face of contrary regulations, even if they are “bootstrap” regulations designed primarily to influence the outcome of litigation.  And for good measure, the Court obliterated the long-held view by many in the tax world that “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under Code section 7805(a) are entitled to less deference than “legislative” regulations promulgated pursuant to more specific rulemaking authority.

The Court’s opinion was authored by the Chief Justice, who was the Justice who spoke out most forcefully during the oral argument in favor of the position that Chevron had superseded earlier decisions in tax cases, as noted in our previous post.  Thus, the opinion sought to be very clear on this point and to identify some of the familiar approaches to regulatory deference in tax cases that the Court was now consigning to the trash heap.  First, the Court pinpointed some of the key factors that had been identified as important under the National Muffler Dealers analysis, stating that under that analysis “a court might view an agency’s interpretation of a statute with heightened skepticism when it has not been consistent over time, when it was promulgated years after the relevant statute was enacted, or because of the way in which the regulation evolved.”  Slip op., at 8-9 (citing Muffler Dealers, 440 U.S. at 477).  The Court continued:  “Under Chevron, in contrast, deference to an agency’s interpretation of an ambiguous statute does not turn on such considerations.”  Id. at 9.

The Court amplified its rejection of the Muffler Dealers analysis by citing a series of non-tax decisions under Chevron that decline to attribute significance to these considerations.  Thus, the Court remarked that it had “repeatedly held that ‘[a]gency inconsistency is not a basis for declining to analyze the agency’s interpretation under the Chevron framework’” (quoting National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 981 (2005)); “that ‘neither antiquity nor contemporaneity with [a] statute is a condition of [a regulation’s] validity’” (quoting Smiley v. Citibank, N.A., 517 U.S. 735, 740 (1996)); and that it is “immaterial to our analysis that a ‘regulation was prompted by litigation’” (quoting Smiley, 517 U.S. at 741).  Trying to link these decisions to its tax law jurisprudence, the Court then observed that in United Dominion Industries, Inc. v. United States, 532 U.S. 822, 838 (2001) (which involved the calculation of product liability losses for affiliated entities under Code section 172(j)), it had “expressly invited the Treasury Department to ‘amend its regulations’ if troubled by the consequences of our resolution of the case.”  Mayo slip op., at 9.  The Court emphasized that it saw no good reason “to carve out an approach to administrative review good for tax law only.”  Id.  Thus, the Court concluded:  “We see no reason why our review of tax regulations should not be guided by agency expertise pursuant to Chevron to the same extent as our review of other regulations.”  Id. at 10.

Second, the Court moved to squash another area where it discerned a difference between Chevron principles and those developed in tax cases – even though the parties had not focused on that point.  Pointing to an amicus brief filed by Professor Carlton Smith arguing for reduced deference because the regulations in Mayo were “interpretive” regulations promulgated pursuant to Treasury’s general rulemaking authority under 26 U.S.C. § 7805(a), the Court acknowledged that there is pre-Chevron authority for the proposition that courts “‘owe the [Treasury Department’s] interpretation less deference’ when it is contained in a rule adopted under that ‘general authority’ than when it is ‘issued under a specific grant of authority to define a statutory term or prescribe a method of executing a statutory provision’” (slip op., at 10-11 (quoting Rowan Cos. v. United States, 452 U.S. 247, 253 (1981)).  The Court tossed that precedent aside as well, ruling that the Rowan statement was not compatible with the current approach to administrative deference, which is unaffected by “whether Congress’s delegation of authority was general or specific.”  Slip op., at 11.

With the Chevron analytical framework in place, the Court made short work of the FICA issue before it.  It reasonably concluded that the statutory text did not unambiguously resolve whether medical residents qualify for the FICA student objection.  Hence, the Court moved to “Chevron stage two” – namely, whether the regulation was a “reasonable interpretation” of the statute.  Observing that “[r]egulation, like legislation, often requires drawing lines” (slip op., at 13), the Court held that it was reasonable for Treasury to establish a rule that anyone who works a 40-hour week, even a medical resident, is not a “student” for purposes of the FICA student exception.

In sum, the Court’s decision in Mayo resolves the deference issues that have recently divided the lower courts in a way that is extremely favorable to the government.  Treasury likely will be emboldened to issue regulations that seek directly to overturn cases that the government loses in court on statutory interpretation issues, or to issue regulations even earlier to sway the outcome of pending litigation before the courts interpret the statute in the first place.  Of course, we have seen that phenomenon already in the Mayo case itself, with respect to the statute of limitations issue litigated in Intermountain and a host of other cases (see here and here), and in other settings.  The Mayo decision will further encourage the Treasury Department to issue such regulations and will make it tougher for taxpayers to prevail in court in the face of those regulations.

 Mayo Foundation – Supreme Cout opinion

Mayo Foundation Oral Argument Tilts Towards the Government and Raises Doubts About the Continuing Vitality of National Muffler Dealers

At oral argument on November 8, several Supreme Court Justices expressed skepticism regarding the claim that medical residents fall within the “student exemption” from FICA taxation.  Although it is always hazardous to predict the outcome of a case from the questions asked at oral argument, it is difficult to envision the taxpayer getting the five votes needed to overturn the court of appeals’ rejection of the exemption.

The Justices’ objections to the taxpayer’s position came from a variety of angles.  Justice Sotomayor focused on the essence of what a medical resident does, suggesting that a person working unsupervised for more than 40 hours per week, and for significant remuneration, is “really not a student.”  Justice Ginsburg focused more on Congress’s intent, suggesting that the exemption seemed directed at “the typical work/study program in a college.”  Chief Justice Roberts observed that the line between student and worker is a difficult one to draw and suggested that it was therefore appropriate to let the IRS draw the line in a categorical way and then defer to the IRS’s interpretation.  Justice Breyer took a different tack, arguing that the IRS’s position was a valid interpretation of a requirement that had been in the regulations for a long time – namely, that the employment has to be “incident” to the study.  Full-time employment, he suggested, would not be “incident” to the study because it is “so big in comparison to the study.”

Justice Alito seemed the most sympathetic to the taxpayer.  He rose to the taxpayer’s defense by offering an alternative reading of word “incident.”  Later, he challenged the government’s counsel to explain why medical residents should not be eligible for the exemption when law students who write briefs are eligible, arguing that the medical residents should be treated as students if their primary motivation is to complete a course of study rather than to earn money.  Justice Ginsburg and the Chief Justice also questioned government counsel, though not as sharply as they had questioned the taxpayer’s counsel.  Justices Scalia and Kennedy were uncharacteristically silent during the argument.  In accordance with his usual practice, Justice Thomas did not speak.  Justice Kagan is recused in the case because of her prior involvement when she was Solicitor General.

In our prior posts on this case (see here, here, and here), we discussed the possibility that this case could be a vehicle for the Supreme Court to address the correct standard for deference to Treasury regulations – that is, whether the more generic Chevron analysis has superseded the more specific, and in some respects less deferential, approach set forth in National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979).  The Justices did not exhibit any independent interest in this issue, as their questions focused on the meaning of the statute, not on deference to the regulation.  At one point in his opening argument, taxpayer’s counsel noted that the new regulation was issued only after the government had repeatedly lost in court (a fact that would argue for less deference under the National Muffler Dealers approach), but that point did not elicit any reaction from the Justices.

Thus, the oral argument did not touch on the Chevron/National Muffler Dealers issue until the very end when taxpayer’s counsel affirmatively raised it during his few minutes of rebuttal time.  Counsel sought again to persuade the Court that the government’s position is suspect because it is a recent invention that seeks to overturn a series of adverse court decisions, and this time phrased the argument explicitly in terms of the standard for deferring to a regulation.  Taxpayer’s counsel argued that deference to the new Treasury Regulation is inappropriate under “[t]he National Muffler standards, which we understand still to be appropriate to evaluate deference given to an IRS regulation,” because the regulation “is not a contemporaneous regulation.”  Justice Sotomayor quickly objected, asserting that the Court has “said that agencies can clarify situations that have been litigated and positions that they have lost on.”  (She was referring here not to tax cases, but to decisions that apply the Chevron analysis.).  Shortly thereafter, Chief Justice Roberts zeroed in on the issue, asking:

Why are we talking about National Muffler?  I thought the whole point of Chevron was to get away from that kind of multifactor ad hoc balancing?

Taxpayer’s counsel tried to respond by arguing that the National Muffler Dealers factors were “sensible factors” that the Court should continue to apply in the case of a “regulation that pops up 65 years of the enactment of the statute, after the government has lost five cases.”  But the Chief Justice was dismissive, stating simply:  “If Chevron applies, those considerations are irrelevant, right?”

The outlook for the case therefore is that the Court will likely affirm the Eighth Circuit’s ruling that medical residents do not come within the student exemption from FICA.  Such a decision would not necessarily require a discussion of deference to Treasury regulations, but if there is such a discussion, the Court may well be ready to conduct the analysis explicitly in the Chevron framework and consign National Muffler Dealers to the dustbin of history.  As noted in our previous post, that would in some respects be an unfortunate outcome – giving too much deference to regulations that may well be unduly influenced by the IRS’s narrow interest in maximizing tax revenues rather than a neutral effort to implement the will of Congress.

Attached below are links to the taxpayer’s reply brief and to the transcript of the oral argument.  A decision is expected in the next few months.

Taxpayer Reply Brief in Mayo Foundation

Transcript of Oral Argument in Mayo Foundation

Briefing Completed in Quality Stores

As we previously reported, a district court in Michigan disagreed with the Federal Circuit’s decision in CSX Corp. v. United States, 518 F.3d 1328 (2008) (opinion linked here), and held that severance payments paid to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes.  The employer, Quality Stores, has now filed its answering brief in the Sixth Circuit defending the district court opinion and addressing the arguments made by the government in its opening brief, and the government has filed its reply brief.  (The briefs are attached below.)

The employer’s main argument is a textual one, based on the interplay between the FICA and income tax withholding provisions of the Code.  Asserting that “wages” should mean the same thing in both sets of provisions, the employer relies on Code section 3402(o), which states that “supplemental unemployment compensation benefits” should be “treated as . . . wages.”  Implicit in this provision, the employer asserts, is the proposition that such “SUB pay” would not otherwise be wages.  Since the severance payments are encompassed within “SUB pay,” it follows that they are not “wages” for FICA purposes.  (FICA does not contain a provision analogous to section 3402(o)).

The Federal Circuit in CSX had rejected the logic of this argument, reasoning that section 3402(o) might imply that some SUB pay is not “wages,” but not that all SUB pay is not “wages.”  In addition to that relatively narrow argument, the government has suggested more broadly that the meaning of “wages” in the income tax withholding context “has no bearing” on its meaning in the FICA context.  The Federal Circuit did not fully embrace that suggestion in CSX, stating that “we disagree with the government’s argument that after 1983, the term ‘wages’ in FICA must be interpreted without reference to the same term in the income tax withholding statutes.”  In its reply brief in Quality Stores, the government focuses primarily on a narrower argument that accords with the Federal Circuit’s approach, contending that section 3402(o) was addressed only to the subset of SUB pay that had been exempted from withholding by certain Revenue Rulings.  Because the payments in this case would not fall within those Rulings, the government reasons, section 3402(o) is irrelevant.

The employer also argues that the Sixth Circuit is bound by the Supreme Court’s decision in Rowan Cos. v. United States, 452 U.S. 247 (1981), to treat SUB pay the same for income tax withholding and FICA purposes.  The government responds that Rowan cannot have that precedential effect after Congress overruled it and passed the “decoupling provision.”

With the briefing now concluded, the parties await the assignment of a date for oral argument, which will likely occur in the winter.  The briefs are complex, and it remains to be seen whether the Sixth Circuit will immerse itself deeply in the issue or, instead, give considerable deference to the decision of its sister circuit in CSX.

Quality Stores – Taxpayer’s Answering Brief

Quality Stores – US Reply Brief

Mayo Foundation Oral Argument Scheduled for November 8

The Supreme Court has released the oral argument schedule for its November session.  The argument in Mayo Foundation is scheduled as the second case on Monday November 8, meaning it will begin around 11:00.  A decision is expected to issue in the spring, almost certainly no later than June 2011.  We will provide a report on the argument in November.

Taxpayers’ Brief Filed in Mayo Foundation

The taxpayers have filed their opening brief in Mayo Foundation, a copy of which is attached.  They argue primarily that the statutory language of the exemption unambiguously includes medical residents, and therefore there is no occasion to consider the reasonableness of the IRS regulation.  Secondarily, they argue that the regulation is in any event arbitrary and unreasonable. 

With respect to the question of the correct deference analysis discussed in our previous post, the brief relies heavily on the National Muffler Dealers factors.  It identifies five factors that militate against the reasonableness of the regulation:  (1) does not harmonize with the origin and purpose of the statute; (2) not contemporaneous; (3) did not “evolve in an authoritative manner” because it was designed to overturn adverse judicial decisions; (4) has not been in effect for long; and (5) the government’s position has been inconsistent.  Although the first factor is basic to any analysis of the reasonableness of a regulation, the other four all come from National Muffler Dealers and are not commonly associated with the Chevron deference analysis applied to non-tax statutes. 

The taxpayers have not asked the Court to choose between Chevron and Muffler Dealers.  To the contrary, they have finessed the possible tension between two lines of cases by purporting to examine “the factors that indicate the reasonableness of a tax regulation under this Court’s decisions in Chevron and National Muffler” and observing that the “Court has given special consideration to several factors identified in National Muffler” “in determining the reasonableness of a regulation interpreting a revenue statute.”  As discussed in our previous post, this approach is entirely consistent with the way the Supreme Court has approached this issue in recent years – that is, citing to the National Muffler Dealers factors in tax cases without addressing whether the analysis is fully consistent with Chevron.  But the courts of appeals have begun to question whether the two approaches are compatible.  It will be interesting to see whether the government’s brief challenges the continuing vitality of the National Muffler Dealers analytical framework.  That brief is due on September 27.

Mayo Foundation – Taxpayers’ Opening Merits Brief

Supreme Court to Address Deference Owed to Regulation Governing FICA Taxation of Medical Residents

In Mayo Foundation, et al. v. United States, No. 09-837, the Supreme Court will consider whether medical residents are exempt from FICA taxation, with the decision likely to turn on the level of deference the Court is willing to accord to a recent regulatory change.  Although the issue may seem obscure, there are 8,000 residency programs in the United States, and the government estimates that $700 million in taxes per year is at stake, with $2.1 billion in refund claims pending.  

The issue involves the meaning of the “student exemption” to FICA, which excludes from the definition of “employment” “service performed in the employ of a school” by a “student who is enrolled and regularly attending classes at such school.”  I.R.C. § 3121(b)(10).  The regulations implementing that statute long provided that “student” status depends on the relationship between the employee and the institution and that when the services are performed “incident to and for the purpose of pursuing a course of study,” the employee can qualify for the student exemption.  Beginning in the late 1990s, there have been several cases addressing whether this exception applies to medical residents, who work more than full-time and earn a $40,000-$60,000 stipend, but perform their duties as part of an educational process in which they also attend classes.

In 2003, a federal district court in Minnesota ruled that the Mayo Clinic’s residents qualified for the student exception under the statute and existing regulations.  The government responded by amending the regulations, effective April 1, 2005, to provide a bright-line rule that does not allow full-time employees to qualify for the exception.  Thereafter, four other courts of appeals ruled against the government, stating that the residents fell within the terms of the statutory exception.  All four of those cases, however, involved pre-2005 periods, and therefore the courts did not directly consider the impact of the amended regulation.   In this case, the first to address the new regulation, the Eighth Circuit held that it owed Chevron deference to the new regulation as a reasonable interpretation of an ambiguous statute.  Thus, contrary to the other four circuits, it sided with the government and held that the residents are subject to FICA taxation.

Most tax cases reach the Supreme Court on the strength of a request for further review by the government, but in this case the Court granted a petition filed by the taxpayers over the government’s opposition.  The taxpayers predictably argued that the circuit conflict, and dollars at stake, necessitated Supreme Court review.  In situations like this, the government often acquiesces in certiorari, because the IRS likes to get circuit conflicts resolved to promote its own institutional interest in uniformity.  In this case, however, the government sought to avoid taking its chances in the Supreme Court by arguing that there was no genuine circuit conflict, because the other four circuits had not considered the new regulation.  Evidently, the government hoped that it could build on this decision and use it to get the other circuits to retreat from their prior decisions and adopt a rule going forward under the new regulation that would subject medical residents to FICA taxation.  The Court, however, was apparently persuaded by the taxpayers that the new regulation is unlikely to lead to a different result in those circuits — because they had already indicated a view that medical residents qualify for the exception under the unambiguous statutory language, which would leave no room for Chevron deference to the new regulation.  

A decision by the Court will, of course, resolve the question of FICA taxation of medical residents — unless Congress steps in.  But the decision could have a much broader impact because it implicates the general topic of deference to IRS regulations, particularly the question whether Chevron deference principles have superseded the more specialized analysis developed over the years in tax cases dating back to National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979).  In recent years, courts of appeals have begun to trend towards applying standard Chevron analysis in tax cases, but the Tax Court has resisted.  See, e.g., Swallows Holding Ltd. v. Commissioner, 126 T.C. 96 (2006), rev’d, 515 F.3d 162 (3d Cir. 2008).  The Supreme Court has not specifically addressed the issue.

There is not a huge difference in the two deference approaches, and, in most cases, choosing between them is not likely to affect the outcome.  Like Swallows Holding, however, this case could be an exception.  Among the factors listed in Muffler Dealers for determining deference that have been oft-applied in later cases are whether the regulation is contemporaneous with the statute and “the consistency of the Commissioner’s interpretation.”  440 U.S. at 477; see also, e.g., United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220 (2001); Cottage Savings Ass’n v. Commissioner, 499 U.S. 554, 561 (1991).  In this case, those factors support the taxpayers’ rejection of the regulation, as the government is arguing for reliance on a new regulatory approach that departs from a 65-year old regulation.  Contemporaneity and consistency, however, play no role in the Chevron analysis, which does not penalize the agency for inconsistency or for promulgating new regulations designed to overturn adverse court decisions.  Indeed, the Court has specifically ruled that prior contrary judicial constructions of a statute do not foreclose owing Chevron deference to a subsequent regulation, unless the court decision had determined that the statute is unambiguous.  National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967, 982-86 (2005).

The parties did not tee up this potential issue in the briefs filed at the certiorari stage.  The court of appeals’ opinion straddled the fence, purporting to apply Chevron but also stating that the Muffler Dealers factors were “instructive” on the second part of the Chevron inquiry – whether the regulation is a reasonable interpretation of the statute.  The certiorari petition focused mostly on the circuit conflict.  To the extent it discussed the merits of the case, it argued that the Eighth Circuit’s decision was inconsistent with Chevron and and did not cite the Muffler Dealers line of cases.  (The petition argued that the Eighth Circuit had “effectively eliminate[d]” the first step of Chevron analysis in tax cases when it stated that, when common words are found in “a provision of the Internal Revenue Code, a Treasury Regulation interpreting the words is nearly always appropriate.”)  The government’s brief was happy to embrace the notion that Chevron governs the deference inquiry.  It will be interesting to see whether the taxpayers try to get more mileage out of Muffler Dealers and its progeny at the merits stage.

The parties will be briefing the case over the summer, with the taxpayers’ opening brief currently due on August 6, 2010.  Oral argument is expected to be scheduled for November or December.  One important note is that this is one of the cases in which Elena Kagan has stated her intent to recuse because she participated in the case as Solicitor General.  That means the case will be decided by an eight-Justice Court, with the possibility of a 4-4 split.  If that occurs, the Court would issue a one-line order affirming the Eighth Circuit’s decision by an equally divided court.  The government’s victory in this case would stand, but the decision would have no precedential value, and the issue would remain in play outside the Eighth Circuit.

The opinion of the Eighth Circuit and the parties’ briefs at the certiorari stage are linked below.  We will provide the briefs on the merits after they are filed.

Mayo Foundation – 8th circuit opinion

Mayo Foundation – cert petition

Mayo Foundation – US brief in opposition

Mayo Foundation – Taxpayers’ reply brief at certiorari stage

U.S. Opening Brief Filed in Quality Stores

On July 13, 2010, the government filed its opening brief in the Sixth Circuit in In re Quality Stores, Inc:  United States v. Quality Stores, Inc., No. 10-1563.  In that case, the government is appealing the district court’s surprising decision holding that severance payments made to employees pursuant to an involuntary reduction in force are not “wages” for FICA tax purposes if they qualify for exclusion from income tax withholding as “supplemental unemployment compensation benefits” (“SUB pay”) under Code section 3402(o)(2).  As the district court acknowledged, its decision directly conflicts with the Federal Circuit’s ruling in CSX Corporation v. United States, 518 F.3d 1328 (2008), which had appeared to resolve this issue definitively in favor of the IRS.  (This Miller and Chevalier Tax and Employee Benefits Alert contains a fuller discussion of the district court’s opinion and the steps that companies can take to protect their rights pending the outcome of the appeal.)

Although the government’s opening brief  relies extensively on CSX, it also addresses the issues comprehensively as if the Sixth Circuit were the first circuit court to consider the issue.  Primarily, the government argues that the case is controlled by Code section 3121, which broadly defines wages as “all remuneration for employment” — a definition that encompasses severance pay.  The government criticizes the district court’s reliance on Code section 3402(o) both because that section relates to income tax withholding, rather than FICA taxes, and because its terms in any event do not dictate that SUB pay is not “wages.”  With respect to the district court’s reliance on Rowan Cos. v. United States, 452 U.S. 247 (1981), the government argues that Rowan does not support exempting SUB pay from FICA taxation and, in any event, Congress’s enactment of the “decoupling provision” in the wake of Rowan eliminates any possible support that the case could lend to the companies’ position.

The answering brief for Quality Stores is currently due September 8, 2010.   Links to the government’s brief and the district court opinion are attached.

US opening brief in Quality Stores

District Court opinion in Quality Stores