By Patrick Temple-West
WASHINGTON (Reuters) - The Obama administration on Tuesday will fight before the Supreme Court to keep a defunct retailer from potentially triggering a wave of tax refund claims that could drain $1 billion from major U.S. social programs.
In oral arguments before the high court, the Obama administration will ask the justices to overturn an appeals court ruling in favor of issuing a tax refund to Quality Stores Inc, a rural retailer that declared bankruptcy in 2001.
Though the tax refund at issue in this case is small - about $1 million - the Obama administration has warned in court filings that the Internal Revenue Service could owe more than $1 billion in thousands of tax refund claims to individuals and businesses if the appeals court ruling is upheld.
At issue is whether severance payments to workers who were involuntarily terminated are taxable under the Federal Insurance Contributions Act tax, or FICA, which helps pay for Social Security retirement pensions and Medicare health insurance for the aged. FICA taxes are paid by a company and its employees.
Midwest-based Quality Stores served mainly farmers and people in small towns before it shuttered all of its 300 stores. Thousands of workers were laid off with severance pay. The company withheld FICA tax from the severance pay and forwarded the withholdings to the government.
In the case before the Supreme Court, the IRS and Quality Stores are arguing over seemingly contradictory language in the tax code related to severance pay and FICA taxes.
SEVERANCE IN TAX GRAY AREA
One part of the tax code defines wages as "all remuneration for employment." The severance payments made by Quality Stores were wages and were taxable for FICA purposes, the Obama administration is arguing, according to court filings.
But in a different section of the code, "supplemental unemployment benefits" are exempted from income taxes. Quality Stores has argued that its severance payments are exempt from FICA taxes according to the "SUB payments" definition.
In September 2012, the 6th U.S. Circuit Court of Appeals ruled that the Quality Stores severance payments to former employees were not wages, and therefore were not taxable under FICA.
In that decision, now before the Supreme Court, the 6th Circuit judges acknowledged the tax code language is "complex" and "the correct resolution of the issue is far from obvious."
Kristin Hickman, a law professor at the University of Minnesota, said: "Both sides have plausible arguments about how the statutes can be interpreted."
OUTCOME HARD TO PREDICT
U.S. Deputy Solicitor General Eric Feigin will argue the case for the government. Quality Stores will be represented by Robert Hertzberg, a lawyer with Pepper Hamilton LLP, who will be making his first Supreme Court appearance.
Hundreds of the company's creditors are paying for legal fees in this case from a bankruptcy trust.
Only eight of the nine justices will hear the oral arguments. President Barack Obama's most recent court appointee, Justice Elena Kagan, is not taking part in the case. She has been sitting out administration disputes from when she served as U.S. solicitor general before her August 2010 court appointment.
A decision is expected by the end of June. Views were mixed on how the case might be decided.
"The court will be fairly unified and sympathetic to the government," said Bradley Joondeph, professor at the Santa Clara University School of Law.
Ruth Wimer, a partner at McDermott Will & Emery LLP, said Quality Stores has an advantage because the government's argument is too simplistic. "The government has a harder argument," Wimer said. "If the statute were clear, we wouldn't have all these cases."
The case is United States v. Quality Stores Inc. No. 12-1408.
(Editing by Kevin Drawbaugh and Jonathan Oatis)