In re Quality Stores, Inc.

• Decision Date: 23 February 2010
• Docket Number: No. 1:09-CV-44.,1:09-CV-44.
• Citation: 424 B.R. 237
• Parties: In re QUALITY STORES, INC., et al., Debtors. United States of America, Defendant-Appellant, v. Quality Stores, Inc., et al., Plaintiffs-Appellees.
• Court: U.S. District Court — Western District of Michigan

424 B.R. 237

In re QUALITY STORES, INC., et al., Debtors.

United States of America, Defendant-Appellant, v. Quality Stores, Inc., et al., Plaintiffs-Appellees.

No. 1:09-CV-44.

United States District Court, W.D. Michigan, Southern Division.

February 23, 2010.

L. Steven Schifano, U.S. Department of Justice, Tax Division, Washington, DC, Michael L. Shiparski, U.S. Attorney, Grand Rapids, MI, for Defendant-Appellant.

Michael H. Reed, Nina M. Varughese, Pepper Hamilton LLP, Philadelphia, PA, Robert Steven Hertzberg, Pepper Hamilton LLP, Detroit, MI, for Plaintiffs-Appellees.

OPINION

JANET T. NEFF, District Judge.

This matter is before the Court on appeal from the Bankruptcy Court. Plaintiffs ("Quality Stores") commenced this adversary proceeding against defendant United States, seeking the refund of $1,000,125 in Federal Insurance Contributions Act¹ (FICA) taxes paid with regard to severance payments to former employees. The Bankruptcy Court, the Honorable James D. Gregg, entered a final judgment in favor of plaintiffs, determining that the payments made to the employees pursuant to the severance programs were not "wages" for purposes of FICA taxation. See Quality Stores, Inc., v. United States (In re Quality Stores, Inc.), 383 B.R. 67 (Bankr.W.D.Mich.2008). The United States appeals that decision.

I. Facts

This case was submitted to the Bankruptcy Court on stipulated facts ("Stip.Facts") for purposes of the parties' cross-motions for summary judgment. The facts, as set forth by the Bankruptcy Court, are not disputed on appeal:

[T]he Debtors operated a chain of retail stores specializing in agricultural supplies and related products. During the period preceding the bankruptcy cases (the "Prepetition Period"), the Debtors were forced to close approximately sixty-three stores and nine distribution centers. The Debtors also terminated approximately seventy-five employees at their corporate office during the Prepetition Period.

On October 20, 2001, an involuntary chapter 11 petition was filed against the Debtors. Quality Stores, Inc., answered the involuntary petition and consented to the entry of an order for relief on November 1, 2001. The remaining Debtors also commenced voluntary chapter 11 cases on November 1, 2001. After the petition date (the "Postpetition Period"), the Debtors closed their remaining 311 stores and three distribution centers. The Debtors also terminated all of their remaining employees.

The Debtors made severance payments to employees who were terminated during both the Prepetition and Postpetition Periods. The parties agree that the severance payments were made "pursuant to [severance plans] maintained by the Debtors." (Stip. Facts ¶ 15.) The parties further stipulate that the severance payments were made "because of the employees' involuntary separation from employment," which resulted "directly from a reduction in force or the discontinuance of a plant or operation." (Stip. Facts ¶ 15.) The severance payments were included in the employees' gross income, and the Debtors reported the severance payments as wages on the W-2 forms issued to employees. The Debtors withheld federal income tax and the employees' share of FICA tax from the severance payments. The Debtors also paid the employer's share of FICA tax with respect to the severance payments.

Under the Prepetition Severance Plan, the Debtors' senior executives received twelve to eighteen months of severance pay. All other employees received one week of severance pay for each full year of service. These payments were not connected to the receipt of state unemployment compensation and were not attributable to the rendering of any particular employment service. The severance payments were paid on a weekly or semi-weekly basis, in accordance with the Debtors' normal payroll period. Approximately $382,362 of the total refund requested in this adversary proceeding is attributable to severance payments made under the Prepetition Severance Plan.

Under the Postpetition Severance Plan, officers received six to twelve months of severance pay. Full-time salaried and hourly employees who had been employed for at least two years received one week of severance pay for each full year of service, up to a maximum of ten weeks for salaried employees and five weeks for hourly employees. Employees who had worked for the Debtors for less than two years received one week of severance pay, and the approximately 900 employees who were subsequently employed by the companies who purchased the Debtors' assets did not receive any severance pay. Like the prepetition severance payments, the postpetition payments were not connected to the receipt of state unemployment compensation and were not attributable to the rendering of any particular employment services. All severance payments for the Postpetition Period were paid in a lump sum. Approximately $617,763 of the total refund requested in this adversary proceeding is attributable to payments made under the Postpetition Severance Plan.

On September 17, 2002, the Debtors filed fifteen separate refund claims with the IRS, seeking to recover $1,000,125 in allegedly overpaid FICA taxes.² On June 1, 2005, the Debtors filed this adversary proceeding. The Debtors' complaint seeks to compel the IRS to turn over the alleged overpaid FICA taxes, plus interest, as property of the Debtors' bankruptcy estate. Because the issue presented in this adversary proceeding is a purely legal question, the parties filed stipulated facts and cross motions for summary judgment. Legal memoranda were filed, oral argument was held, and the court took the matter under advisement.

^{n. 2.} This amount includes the employer's share of FICA taxes paid by the Debtors and the employees' share of FICA taxes for those employees who consented to permit the Debtors to make the refund request on their behalf.

II. Issue and Legal Rulings

This case presents a straightforward, but legally-confounding question: whether severance payments qualify as "wages" subject to FICA taxation. As framed by the United States, the more specific issue is whether the debtor is liable for FICA taxes on payments to employees upon their termination of employment because of the downsizing and subsequent closing of operations by their employer, even though the payments are not connected to or contingent on the recipients' eligibility for state unemployment compensation benefits (Def.Br.7).

The few courts that have addressed this issue, or variations of it, have reached directly opposing outcomes. Where one court has found severance payments to be subject to taxation, the next has reached the opposite conclusion. The fact that the Internal Revenue Service has itself charted a path of "reverse-course" rulings on this issue since the 1950s only adds to the difficulties faced by the courts in attempting to reach a reasoned resolution by explaining and accounting for this repeated change in agency position.

To say that these differing rulings are simply the product of results-oriented decision-making is tempting, but unsupportable. The courts have not only diligently wrestled with the justification for their conclusions, but also endeavored to fashion some appropriate, logical framework for the analysis of this issue.

After a thorough consideration of the parties' arguments, the Bankruptcy Court concluded that the severance payments made to the employees pursuant to the Pre- and Postpetition Severance programs were not "wages" for purposes of FICA taxation. Quality Stores, 383 B.R. at 78. The Bankruptcy Court relied in part on the analysis and resolution of this same legal question by the Federal Court of Claims in CSX Corp., Inc. v. United States, 52 Fed.Cl. 208 (Fed.Cl.2002). After the decision by the Bankruptcy Court, however, the United States Court of Appeals for the Federal Circuit reversed, in key part, the lower court's decision in CSX. See CSX Corp. v. United States, 518 F.3d 1328 (Fed.Cir.2008). Given the reversal, the United States moved for reconsideration of the Bankruptcy Court's decision in this case. The Bankruptcy Court granted the motion for reconsideration, and on reconsideration, ratified its prior opinion and order.

Having now the benefit of these courts' prior efforts and analysis, this Court concludes that the severance payments at issue are not properly classified as "wages," and therefore, are not subject to FICA taxation. Accordingly, the decision of the Bankruptcy Court is affirmed.

III. Standard of Review

This case was before the Bankruptcy Court on the parties' cross-motions for summary judgment. The Bankruptcy Court granted summary judgment in favor of Quality Stores. On appeal to this Court from a bankruptcy court's final order or judgment, the bankruptcy court's conclusions of law are reviewed de novo. Pierce v. Underwood, 487 U.S. 552, 557-58, 108 S.Ct. 2541, 101 L.Ed.2d 490 (1988); In re Rowell, 359 F.Supp.2d 645, 647 (W.D.Mich. 2004). Issues of statutory interpretation are questions of law, and are thus subject to review de novo. ITT Indus. v. BorgWarner, Inc., 506 F.3d 452, 457 (6th Cir. 2007). The district court may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings. FED. R. BANKR.P. 8013.

Federal Rule of Civil Procedure 56 governs summary judgment in bankruptcy court adversary proceedings. FED. R. BANKR.P. 7056; In re Rowell, 359 F.Supp.2d at 647. Thus, the motion for summary judgment is properly granted "if the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law." FED.R.CIV.P. 56(c).

IV. Analysis

The essential issue presented is whether the severance payments to employees/former employees of Quality Stores constitute taxable "wages" for purposes of FICA. There is no dispute that if the severance payments...