Sixth Circuit Finds Unpaid Wage Suit Was Really a Request for IRS Refund

Many states like Ohio have their own wage payment statutes which require employers to pay employees all of their wages by a particular date unless the employee has authorized certain deductions or unless deductions are required by law (such as payroll taxes). When employees are not paid (at all or on time), they not only sue for breach of contract, but also for violation of the wage payment statute.  However, last month, the Sixth Circuit found one such lawsuit for unpaid wages was really a request for an IRS refund because the employer had purportedly deducted not only the employee’s share of payroll taxes from her wages, but also its share of the payroll taxes.   Berera v. Mesa Medical Group, PLLC., No. 14-5054 (6^th Cir. 2-19-15).  According to the Sixth Circuit, the plaintiff’s only remedy for these improper payroll deductions was to seek a refund from the IRS instead of suing her employer under the state wage payment statute for wrongfully deducting amounts from her wages.  Therefore, it dismissed her suit for unpaid wages and directed her to seek repayment only from the IRS.

According to the Court’s opinion, the plaintiff discovered after her employment ended that her W-2 tax form did not accurately reflect the wages she had earned.  A few months later, she filed a class action in state court and alleged under the state wage payment law that that the employer had forced her and her co-workers to pay the employer’s share of payroll taxes and caused them to receive less money than they had earned as wages. After learning that the basis of the lawsuit concerned wrongfully withheld payroll taxes, the employer removed the case to federal court and moved to dismiss.  The trial court found that the allegations actually stated a claim for a tax refund, even if the employer failed to remit the wrongfully withheld payroll taxes to the IRS, because the amounts were deducted as a tax. The Sixth Circuit affirmed.

Section 7422(a) of the Internal Revenue Code governs tax-refund lawsuits. It provides:   

No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the [IRS], according to the provisions of law in that regard, and the regulations of the [IRS] established in pursuance thereof.

26 U.S.C. § 7422(a).

The exhaustion-of-remedies requirement in § 7422(a) is mandatory. Under § 7422(a), a taxpayer is barred from bringing an action in federal court for a refund of any internal revenue tax or sum erroneously, illegally, or wrongfully assessed “until a claim for refund . . . has been duly filed with the [IRS].”

Both the Third and Seventh Circuits have held that employees cannot sue their employers for wrongfully withheld payroll taxes, but must instead, seek a refund from the IRS. Those courts concluded that the federal tax laws completely pre-empted any inconsistent state law remedy.  The Sixth Circuit declined to find complete pre-emption, but agreed that the plaintiff must exhaust her administrative remedies before pursuing litigation.  

The Court rejected the plaintiff’s argument that the IRS would not be able to provide her with a remedy if the employer had failed to remit the wrongfully withheld payroll taxes.  Instead, the Court agreed with the other Circuits that if the employer had failed to remit the wrongfully withheld taxes to the IRS, the IRS was capable of collecting it.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.

 

Settlement Agreement’s Silence About Tax Treatment Leaves Parties to Fend for Themselves

On Monday, the Sixth Circuit Court of Appeals in Cincinnati issued a decision about whether a bank breached a settlement agreement involving a home mortgage in Blacklick.  McClusky v. Century Bank, FSB, No. 14-3419 (6^th Cir. 1-26-15).  In that case, the parties settled their case with the forgiveness of a disputed amount of the debt and the trial court entered the judgment entry merely noting that the dispute had been resolved.  The Bank later issued a 1099 tax form to the plaintiff for the amount of the cancelled debt, raising his taxes by almost $70K.  He then sued for breach of the settlement agreement, which said nothing about the tax treatment of the cancelled debt.   The Court held that because the settlement agreement and judgment entry did not put any limitations on how the Bank could treat the cancelled debt for tax purposes, there was nothing limiting the Bank from issuing the 1099.  Accordingly, when employment disputes are resolved without an agreement about the tax treatment of any settlement payments, the employer would similarly be free to issue appropriate tax forms based on its own reasonable characterization of the payments.

As noted by the Court:

 The Settlement Order says nothing about how each party would treat the transaction memorialized in the Settlement Order for tax purposes nor about how (or whether) each party would report the transaction to the IRS. Given the complete absence of any reference to tax reporting issues, the Settlement Order cannot be read as precluding Century Bank from issuing the McClusky 1099. Indeed, it would violate Ohio’s fundamental rules of contract interpretation to read into the Settlement Order a limitation on Century Bank’s conduct that the order simply does not contain.

                . . .

The absence of any reference to tax treatment/reporting issues in the Settlement Order is especially significant because it is common practice for parties to address these matters in settlement agreements when the parties have, in fact, agreed upon them. Indeed, one treatise on Ohio law advises Ohio attorneys drafting a settlement agreement to specify the tax  consequences that the parties intend to govern the agreement.

 In reaching this conclusion, the Court considered cases from other jurisdictions where the parties had agreed how to characterize the payments, to keep the payments confidential and even to not subject them to any tax withholding.  Nonetheless, the courts refused to find a breach of contract when the payor issued 1099 tax forms to the payee in the absence of a specific contractual promise to not issue such a tax form.

This being said, the Court took no position on whether the cancelled debt constituted taxable income and did not endorse permitting a payor (such as an employer) to make tax withholdings in the absence of a contractual provision entitling it to do so.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.

Supreme Court: Severance Payments Are Wages Subject to FICA Withholding

This morning, a unanimous Supreme Court held that severance payments made to involuntarily terminated employees constitute “wages” for purposes of FICA withholding.   U.S. Quality Stores, Inc., No. 12-1408 (3-25-14).   In that case, the employer made severance payments to employees who were laid off during the employer’s bankruptcy.  The amount of the payments varied depending on their position and length of service. Although it initially made the required FICA withholding from the payments, it later sought a refund on the grounds that severance pay is exempt from FICA withholdings.  The IRS did not respond.  The bankruptcy court granted summary judgment against the IRS in favor of the employer and was affirmed by the district court and Sixth Circuit.    However, the Supreme Court found that “wages” as defined in FICA included all renumeration for employment and the exceptions merely highlighted that regular severance pay constituted wages.   Based in part on legislative history, the Court rejected the IRC language treating supplemental unemployment benefits “as if” they were wages meant that severance pay also fell outside the definition of wages.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.

Government to Subsidize 65% of Medical Continuation Coverage for Involuntarily Terminated Employees

The recently enacted American Recovery and Reinvestment Act of 2009 (the “Act”) contains a provision where the federal government will partially subsidize the continuation of medical insurance coverage for involuntarily terminated employees for up to nine months if they are eligible for continued medical coverage under COBRA or similar state law. (Ohio has a mini-COBRA statute that applies to employers which are not otherwise covered by COBRA at Ohio Revised Code 3923.38). The continued medical coverage is available to any employee who participates in an employer-sponsored health plan and who is involuntarily terminated after September 1, 2008 but before December 31, 2009 – even if the employee did not initially elect to continue medical coverage after his or her termination.

The government is partially subsidizing the insurance coverage by requiring employers to pay for 65% of the monthly premium and then recoup that amount from the quarterly payroll and FICA taxes the employer would otherwise be required to pay. Of course, the employee has to elect to continue medical coverage under the new Act and pay his or her 35% share of the monthly premium before the employer can reimburse itself through payroll tax withholdings. If the employee already paid the 102% share of the premium (for months after February 17, 2009), the employer can either reimburse the employee for the 65% or credit the overpayment towards premium payments for the next two months. (The subsidy cannot be used for months prior to February 17, 2009). Employers will also need to file a report with the IRS concerning the involuntary termination of an employee covered by the new Act, the amount of the payroll taxes used to reimburse the employer for the 65% of medical insurance continuation and the Tax Identification Numbers of all covered employees. The IRS will issue regulations and other guidance concerning the form and content of such reports.

The employee may elect to continue the same insurance coverage which the employee utilized during active employment, or if the employer permits it, the employee may elect a less expensive medical plan if such plan is also offered to the employer’s active employees and such plan offers more than merely dental, vision, flexible spending or an on-site clinic at the employer’s facility.

The subsidy will not constitute taxable income to the employee, unless the employee’s adjusted gross income exceeds $125,000 (for single filers) or $250,000 (for joint filers). These high income employees may elect to waive the subsidy in order to avoid having the amount of their taxes increased by the full amount of the subsidized premium (or a significant fraction of that amount).

As mentioned, the government subsidy is available for up to nine months, but may terminate earlier when the employee becomes eligible (i) for COBRA coverage eighteen months earlier (i.e., the nine month subsidy does not extend COBRA’s regular 18-month eligibility period); (ii) under another employer’s medical plan, social security income or Medicare; (iii) for coverage under a flexible spending arrangement or (iv) for coverage for treatment that is furnished in an on-site medical facility maintained by an employer which consists primarily of first-aid services, prevention and wellness or similar care. Employees are required to notify employers if they obtain other medical coverage or risk a 110% penalty.

Employees who did not earlier elect continued medical coverage have 60 days to elect subsidized coverage once they receive the employer’s revised notice of eligibility. The revised notice of eligibility must be sent to any employees terminated between September 1, 2008 and December 31, 2009 and must notify recipients of:
• The availability of subsidized premiums for continued coverage;
• The option to enroll in different coverage (if the employer permits this option);
• The forms necessary for establishing eligibility for subsidized premiums;
• The name, address and telephone number necessary to contact the plan administrator and any other person maintaining relevant information in connection with the subsidized premiums;
• The extended election period (for employees who failed to timely elect COBRA coverage prior to February 17, 2009); and
• The employee’s obligation to notify the plan if the employee becomes eligible for other medical coverage or social security income and the penalty for failing to comply with this obligation;

The Department of Labor is required to publicize acceptable model notices by mid-March 2009 and employers are required to send by mid-April 2009 the revised notice to all employees involuntarily terminated since September 1, 2008.

Insomniacs can read these provisions of the Act in full at http://www.dol.gov/ebsa/pdf/COBRAPremiumReductionProvision.pdf. The Department of Labor expects to publish the new model COBRA notice on its website at http://www.dol.gov/ebsa/cobra.html.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with an attorney.