Understanding Employee Benefits and key developments in the employee benefits field and items of interest to our clients. MORE

Verizon Communications, Inc. sponsored a number of plans for its foreign employees. These employees were citizens of foreign countries who never worked in the United States. Because these employees never worked or resided in the United States, their employment income and the benefits from their retirement plans were foreign source income not subject to U. S. taxes.

Despite the fact that no U.S. income taxes should have been withheld, Verizon’s withholding agents nevertheless withheld taxes from payments made to the employees. When the employees complained, Verizon and the withholding agents promised to stop the withholding and issue a refund. However, the withholding did not stop and no refunds were forthcoming. On the other hand, the employees did not file tax refund claims with the IRS.

The employees sued under ERISA claiming it was a breach of fiduciary duty for employers to withhold taxes that were not owed. The U.S. District Court for the District of Illinois recently dismissed the claim based on a federal statute that prohibits lawsuits to restrain the assessment or collection of any tax. 26 USC § 7421. The court held that this statute precluded the employees’ suit even though the employer knew that the withholding was incorrect and promised multiple times to stop the incorrect withholding. The federal statute trumped both an action to recover the improperly withheld taxes and an injunction to prevent the withholding from continuing. Instead, the employees’ remedy was a refund suit with the IRS.

The court suggested that the result might be different if the withholding agent had not in fact remitted the taxes to the IRS but instead had pocketed the amounts. However, since the IRS had been paid the taxes, the court would not order the employer to stop the withholding. According to the court “It appears that Congress wanted employers (and other tax-collection agents) to be more afraid of the IRS than lawsuits from employees, and it gave them broad protection in the form of § 7422 to effect seamless tax collection.”

The lesson to employees is to make sure that they timely request a refund from the IRS of taxes improperly withheld from benefit plan payments. Although employers might on their own provide refunds, if they do not, an employee’s sole recourse is to the IRS.

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