Supplemental Unemployment Benefit Plans, (SUB plans), have been the focus of scrutiny for the past several months. Employers have been uncertain whether or not they could use SUB plans as part of their benefits package without being subject to compliance and regulatory concerns. A 2014 Supreme Court case provides some important guidance for these plans.
In a 2014 ruling by the Supreme Court, the justices unanimously agreed that Quality Store’s severance payments, which were determined to be a SUB plan, were not exempt from federal employment taxes. This decision reconciles two conflicting appellate court decisions and supports the long-held IRS position that severance and some SUB payments are not exempt from federal employment taxes. Quality Stores, Inc. was a retailer which entered Chapter 11 bankruptcy in 2001 and terminated thousands of employees.
In its decision, the court noted that the Quality Stores payments were not linked to the receipt of state unemployment benefits and the amounts paid varied based upon seniority and years of service. As a result, the amounts were considered wages subject to FICA and FUTA.
Things to Note Regarding the Proper Administration of SUB Plans as a Result of this Ruling:
- To be exempt from FICA & FUTA, payments made from SUB plans must be dependent on the actual receipt of state unemployment benefits.
- Based upon the legislative and operational history cited in the court’s opinion, payments from SUB plans are meant to be a supplemental amount, in addition to state unemployment benefits, and in an amount which does not disqualify the employee from receiving the state unemployment benefits.
- In its Opinion on the case, the court noted that the IRS currently exempts some SUB plans’ benefit payments from FICA and FUTA, but only those which are tied to the receipt of state unemployment benefits and which it has defined in IRS revenue rulings.
A Few Things to Consider When Consulting your TPA, Attorney or Tax Professional:
- How has your SUB plan administrator handled proof of receipt of unemployment benefits prior to paying distributions from the SUB plan?
- How has your SUB plan administrator assured that the SUB plan distributions are in fact supplementing the unemployment benefit, i.e. normal wages, net of taxes and net of the payment from the state unemployment office?
- In light of these requirements, how is your SUB plan administrator ensuring that they are not over-funding employee’s accounts?
- Could there be significant back taxes as a result of this ruling for unpaid FICA & FUTA (i.e. if the SUB plan has been operating in a different fashion than from described above)?
SUB plans are still a viable benefit if they are administered according to the IRS revenue rulings, including verification of receipt of State unemployment benefits payments, are paid as a supplement that is net of the State unemployment benefits received, and are due to an actual layoff, reduction in force or plant closure.
If your company has a SUB plan, they’ll want to navigate these compliance waters carefully, including consulting their current TPA, attorney or tax professional about all of these changes.