United States v. Quality Stores, Inc. (In re Quality Stores, Inc.)

In re: QUALITY STORES, INC., et al., Debtors UNITED STATES OF AMERICA, Appellant, v. QUALITY STORES, INC., et al., Appellees.

No. 10-1563

UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

Argued: October 6, 2011

Decided and Filed: September 7, 2012

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit Rule 206

File Name: 12a0313p.06

Appeal from the United States District Court

for the Western District of Michigan at Grand Rapids.

No. 09-00044—Janet T. Neff, District Judge.

Before: BOGGS and STRANCH, Circuit Judges; and CARR, District Judge.^*

COUNSEL

ARGUED: Francesca U. Tamami, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant. Robert S. Hertzberg, PEPPER HAMILTON LLP, Detroit, Michigan, for Appellees. Mary B. Hevener, MORGAN, LEWIS & BOCKIUS LLP, Washington, D.C., for Amicus Curiae. ON BRIEF: Francesca U. Tamami, Gilbert S. Rothenberg, Kenneth L. Greene, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant. Robert S. Hertzberg, PEPPER HAMILTON LLP, Detroit, Michigan, Michael H. Reed, Nina M. Varughese, PEPPER HAMILTON LLP, Philadelphia, Pennsylvania, for Appellees. Mary B. Hevener, Christopher A. Weals, David R. Fuller, MORGAN, LEWIS & BOCKIUS LLP, Washington, D.C., Robert A. Long, COVINGTON & BURLING LLP, Washington, D.C., for Amici Curiae.

OPINION

JANE B. STRANCH, Circuit Judge. This appeal arises from an adversary action filed in the bankruptcy court for the Western District of Michigan by Quality Stores, Inc., its affiliated companies, and certain employees (collectively Quality Stores) against the United States seeking a refund of $1,000,125 in taxes paid under the Federal Insurance Contributions Act (FICA).¹ On stipulated facts and cross-motions for summary judgment, the bankruptcy court ordered a full refund, holding that payments Quality Stores made to its employees upon terminating their employment involuntarily due to business cessation constituted supplemental unemployment compensation benefits (SUB payments) that are not taxable as wages under FICA. Quality Stores, Inc. v. United States (In re Quality Stores, Inc.), 383 B.R. 67 (Bankr. W.D. Mich. 2008). On appeal, the district court affirmed, United States v. Quality Stores, Inc. (In re Quality Stores, Inc.), 424 B.R. 237 (W.D. Mich. 2010), and we now AFFIRM.

I. FACTS

Quality Stores was the largest agricultural-specialty retailer in the country serving farmers, hobby gardeners, skilled trade persons, and do-it-yourself customers. In October 2001, an involuntary Chapter 11 bankruptcy petition was filed against Quality Stores, Inc. Within two weeks, Quality Stores answered the petition and consented to the entry of an order for relief. Thereafter, Quality Stores's affiliated companies commenced voluntary Chapter 11 bankruptcy cases.² In May 2002, the bankruptcy court confirmed the First Amended Joint Plan of Reorganization.

Prior to November 1, 2001, Quality Stores closed sixty-three stores and nine distribution centers and terminated the employment of approximately seventy-five employees in the corporate office. After November 1, 2001, Quality Stores closed its remaining 311 stores and three distribution centers and terminated the employment of all remaining employees.

Quality Stores made severance payments to those employees whose employment was involuntarily terminated. The parties stipulated that the severance payments resulted directly from a reduction in force or the discontinuance of a plant or operation. Quality Stores made the severance payments pursuant to two separate plans.

Under the terms of the Pre-Petition Severance Plan, severance pay was based on job grade and management level in the organization. The President and CEO received eighteen months of severance pay. Senior management executives received twelve months of severance pay, while all other managers and employees received one week of severance pay for each full year of service. These severance payments were not tied to the receipt of state unemployment compensation, and they were not attributable to the provision of any particular services by the employees. Quality Stores made the severance payments on the normal payroll schedule. Salaried employees received an average of 11.4 weeks of severance pay, while hourly employees received an average of 4.2 weeks of severance pay.

The Post-Petition Severance Plan was designed to encourage employees to defer their job searches and dedicate their efforts and attention to the company by assuring them that they would receive severance pay if their jobs were eliminated. To be eligible for severance pay, an employee was required to complete the last day of service as scheduled. Company officers received between six and twelve months of severance pay, while full-time salaried and hourly employees who had been employed for at least two years received one week of severance pay for every full year of service, up to a maximum of ten weeks for salaried employees and five weeks for hourly employees. Those workers with less than two years of service received one week of severance pay.

Severance payments made under the Post-Petition Severance Plan were not tied to the receipt of state unemployment compensation, nor were they attributable to the provision of any particular services. The post-petition severance amounts were paid in a lump sum, however, because the companies were liquidating and it was not practical administratively to pay the amounts over time. Under the Post-Petition Severance Plan, on average, salaried employees received 5.2 weeks of severance pay, while hourly employees received 3.1 weeks of severance pay. About 900 employees did not receive any severance pay because they were hired immediately by successor companies.

Quality Stores did not require employees to prove that they were unemployed in order to receive severance pay under either plan. Because the severance payments constituted gross income to the employees for federal income tax purposes, Quality Stores reported the payments as wages on W-2 forms and withheld federal income tax. Quality Stores also paid the employer's share of FICA tax and withheld each employee's share of FICA tax. For the taxable quarters ending December 31, 1999, through June 30, 2002, Quality Stores filed timely Forms 941 reporting wages paid to employees and remitted the applicable FICA taxes.

Of the total $1,000,125 in FICA tax at issue, $382,362 is attributed to severance payments made under the Pre-Petition Severance Plan, consisting of $214,000 for the employer share and $168,362 for the employee share. Further, of the total amount of FICA tax at issue, $617,763 is attributed to severance payments made under the Post-Petition Severance Plan, consisting of $357,127 for the employer share and $260,636 for the employee share.

Although Quality Stores collected and paid the FICA tax, it did not agree with the Internal Revenue Service (IRS) that the severance payments constituted wages for FICA purposes. Quality Stores took the position that the payments made to its employees pursuant to the plans were not wages but instead constituted SUB payments that were not taxable under FICA.

Quality Stores asked 3,100 former employees to allow the company to file FICA tax refund claims on their behalf. See Treas. Reg. § 31.6402(a)-2. Of those contacted, 1,850 former employees allowed Quality Stores to pursue FICA tax refunds for them.

In September 2002, Quality Stores timely filed with the IRS fifteen Forms 843 seeking the refund of $1,000,125 in FICA tax.³ This figure consisted of $571,127 for the employer share and $428,998 for the employee share attributed to those employees who granted Quality Stores consent to pursue their claims. When the IRS did not allow or deny the refund claims, Quality Stores filed an adversary action in the bankruptcy court in June 2005.

II. STANDARD OF REVIEW

When we consider an appeal from a district court judgment in a case that originated in bankruptcy court, we review the bankruptcy court's decision directly, without giving any deference to the district court's decision. Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d 838, 849 (6th Cir. 2002). Because the bankruptcy court decided the case on stipulated facts and cross-motions for summary judgment, our review is de novo. See id.

III. ANALYSIS

The concept of SUB payments first appeared in the 1950s and "evolved from the demand by organized labor for a guaranteed annual wage." Coffy v. Republic Steel Corp., 447 U.S. 191, 200 (1980). Because the unions' real concern was the significant difference between average weekly earnings received when employed and the amount of unemployment benefits received when unemployed, the unions sought corporate supplementation of existing state unemployment compensation programs. See id. Several industries adopted SUB plans, the purpose of which was to assure workers of employment security regardless of the number of hours actually worked, rather than to provide employees with additional compensation for work performed. Id. SUBpayments "cannot be compensation for work performed, . . . for they are contingent on the employee's being thrown out of work; unless the employee is laid off he will never receive SUB payments. In this sense, SUB's are analogous to severance payments: they are 'compensation for loss of jobs.'" Id. (quoting Accardi v. Pa. R.R. Co., 383 U.S. 225, 230 (1966) ("[T]he cost to an employee of losing his job is not measured by how much work he did in the past . . . but by the rights and benefits he forfeits by giving up his job.") SUB payments are "in the nature of a reward for length of service, and do not represent deferred short-term compensation for services actually rendered." Id. at 205.

Consistent with these principles, Quality Stores developed two written plans to administer severance payments to the managers and hourly employees who permanently lost their jobs due to the cessation of business caused by bankruptcy. The...