U.S. Supreme Court Rules that Severance Payments are Taxable Wages Under FICA

severance_contract_example_imageBY:  RACHEL D. GEBAIDETIMOTHY C. HAUGHEE

MARCH 31, 2014

The U.S. Supreme Court issued its opinion last week in United States vs. Quality Stores, Inc., in which the Court ruled that severance payments made to former employees who were involuntarily terminated by their former employer were taxable wages for Federal Insurance Contributions Act (FICA) purposes.

In the case, the Respondent, Quality Stores, Inc., made severance payments to numerous former employees who were involuntarily terminated as part of the company’s bankruptcy plan.  The company paid and withheld taxes required under FICA, but later sought a refund from the Internal Revenue Service (IRS) on behalf of itself and its former employees based on the company’s belief that the severance payments should not have been taxed as wages under FICA.  After the IRS failed to act on the company’s request for a refund, the company brought suit in federal district court.  Although the district and appellate courts held that severance payments are not “wages” under FICA, the U.S. Supreme Court disagreed.

In its opinion, the U.S. Supreme Court emphasized that FICA defines the term “wages” broadly and that, as a matter of plain meaning, severance payments fit the definition of “wages” because they are a form of remuneration made only to employees in consideration for employment.

The high court’s opinion discusses two severance plans offered by Quality Stores.  In the first plan, severance was determined by the length of an employee’s years of service to the company.  In another plan, severance was contingent on the employee staying employed by the company for a specific period of time.  Under both plans, the severance was tied to the employees’ employment and was additional remuneration for the employees’ services.  The opinion does not squarely address the question of whether severance offered by an employer to a former employee that is not part of a severance plan – but simply a dollar amount in exchange for a release – would constitute “wages” under FICA.  The opinion, however, suggests that the broad definition of wages under FICA would encompass those severance payments as well.

As a result of the U.S. Supreme Court’s opinion, employers who make severance payments to their former employees should treat the severance payments as taxable wages and should therefore withhold and pay the required FICA taxes associated with the severance payments.

Be Sociable, Share!

Leave a Reply

Your email address will not be published. Required fields are marked *