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CCH® PAYROLL — 4/23/08

Settlements in lieu of retiree health coverage are subject to FICA

The IRS has stated in two information letters that settlement amounts paid by an employer directly to an employee in lieu of retiree health care coverage are subject to FICA tax. Generally, the IRS Code and regulations exclude from the definition of wages payments made by an employer under a plan or system that provides for sickness or accident disability benefits.

In these cases, the IRS used the “origin of the claim” doctrine to determine the proper tax treatment of the court settlements. The doctrine focuses on the nature of the claim that led to the award or settlement. According to the IRS, economic recoveries of back pay arising out of an employment relationship are includable in income and subject to FICA withholding, even if the amounts recovered are paid in lieu of nontaxable fringe benefits. The IRS cited United States v. McKean, 33 Fed.Cl. 535 (1995) and IRS Rev. Rul. 75-241, 1975-1 CB 316, as authority. (IRS Information Letter, INFO 2008-0001, March 28, 2008; IRS Information Letter INFO 2008-2006, March 28, 2008.)

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