Protective Tax Refund Claim - John R. Dundon II, Enrolled Agent
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Protective Tax Refund Claim

Protective Tax Refund Claim

Protective refund claims are filed to preserve a taxpayer’s right to claim a refund when the taxpayer’s right to the refund is contingent on future events like future litigation, and may not be determinable until after the statute of limitations expires. Without a protective refund claim, taxpayers will only have a three-year statute of limitations in which to seek a refund.

For example as I’ll describe below a taxpayer who paid FICA tax in 2009 on severance pay will only be eligible to receive a refund of these payments until April 15, 2013, unless the taxpayer files a protective refund claim.

A protective claim can be either a formal claim or an amended return (1040X, 1120X, etc.) for credit or refund. A protective claim does not have to state a particular dollar amount or demand an immediate refund. However, to be valid, a protective claim must:
• Be in writing and be signed;
• Include the taxpayer’s name, address, social security number or individual taxpayer identification number, and other contact information;
• Identify and describe the contingencies affecting the claim;
• Clearly alert the IRS to the essential nature of the claim; and
• Identify the specific year(s) for which a refund is sought.

Generally, the IRS will delay action on the protective claim until the contingency is resolved. Once the contingency is resolved, the IRS may obtain additional information necessary to process the claim and then either allow or disallow the claim.

Taxpayers can mail a protective claim for refund to the address listed in the instructions for Form 1040X, under Where To File.

Here is an example of when a protective refund claim is in order. In February 2010, a federal district court in U.S. v. Quality Stores, Inc., (DC MI 2/23/2010) 105 AFTR 2d 2010-1110, ruled that severance payments made to terminated employees by a company going out of business were not “wages” subject to FICA. The Court said that “…where severance payments are intended to serve the same purpose as social security benefits, i.e., support for workers in lieu of a lost ability to earn wages, the collection of social benefit taxes on the wage-replacement benefits makes little sense.”

The Court believed that the severance payments were in effect supplemental unemployment compensation benefits, not taxable remuneration for the employees’ services or wages and reasoned that the severance payments were not subject to taxation for FICA purposes.

The IRS has indicated it will appeal the decision, and will continue to deny claims for a refund of FICA tax paid on severance payments.

The IRS continues to rely on CSX Corp. v. U.S., (Ct of Fed Cl 4/1/02) 89 AFTR 2d 2002-1935, that severance payments are “wages” for FICA tax purposes, there is no statutory exception to exclude them from taxation, and they are not “supplemental unemployment benefits” because they are not conditioned on eligibility for, or receipt of, state unemployment benefits.

Taxpayers should file protective claims to preserve their right to receive a refund if Quality Stores is upheld on appeal on the off chance that we experience clarity as to whether severance packages are subject to FICA tax.