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Severance Payments are Wages Subject to FICA Taxes

On March 24, 2014, the U.S. Supreme Court held in United States v. Quality Stores, Inc., 572 U.S. ____ (2014), No. 12-1408, that severance payments made to employees terminated in connection with a company’s Chapter 11 bankruptcy plan are taxable wages under the Federal Insurance Contributions Act (FICA). The ruling resolves a split among federal circuits and affects all employers who provide severance pay.

Quality Stores filed a Chapter 11 bankruptcy petition and terminated thousands of employees, who received severance payments based on title, length of service, and willingness to continue working for a specified period of time in the company’s post-bankruptcy operation. The company first reported the severance payments as wages, paying the employer’s portion of FICA taxes and withholding the employee’s share. Later, Quality Stores applied for a refund. The Internal Revenue Service did not respond, so the company initiated a proceeding in bankruptcy court on behalf of itself and the affected employees. The bankruptcy court granted summary judgment in the company’s favor, held that the payments did not constitute taxable wages, and ordered the refund. The U.S. District Court for the Western District of Michigan and the Sixth Circuit Court of Appeals affirmed. The U.S. Supreme Court granted review.

Quality Stores argued that severance payment to employees who are laid off are not “wages” subject to FICA taxes. The United States maintained that such payments fell within Congress’s broad definition of “wages” under FICA, which includes “all remuneration for employment.” According to the government, severance payments must meet certain criteria in the IRS Rulings to be exempt from taxation for FICA purposes. The company asserted that the severance payments were actually “supplemental unemployment compensation benefits” (“SUBs”) and, therefore, not taxable. The IRS countered that precedents made it clear that payments made after the employment relationship ends are wages under the act’s expansive definition.

The U.S. Supreme Court reversed the Sixth Circuit in a unanimous decision delivered by Justice Kennedy, with Justice Kagan abstaining. The Court did agree with Quality Stores that severance payments were SUBs. However, noting that the Internal Revenue Code chapter governing income tax withholding does not limit the meaning of “wages” for FICA purposes, the Court decided that all SUBs were wages and therefore taxable. The Court examined the history of the statute and concluded that Congress had sought to eliminate a conflict in taxation of unemployment benefits among the states by amending the statute to treat all SUBs, including severance payments, “as if” they were wages subject to withholding. Therefore, it became irrelevant as to whether the severance payments were tied to the receipt of state unemployment benefits.

Kembra Sexton Taylor

Kembra Sexton Taylor, a partner located in the firm’s Frankfort office, practices in the areas of labor and employment, personnel, administrative, regulatory, appellate, and insurance defense law. She has extensive experience in representing clients regarding wage and hour, OSHA, state personnel, and other regulatory matters. She can be reached at taylor@mmlklaw.com or (502) 223-1200.

This article is intended as a summary of federal and state law and does not constitute legal advice.

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