Corporate Law Blog

Severance Payments Do Not Escape FICA

If you are an employer or are responsible for payroll taxes at your business, then this post is a must- read. Recently, the United States Supreme Court issued a decision in United States v. Quality Stores, Inc. and declared that lump sum severance payments made to laid-off employees are taxable wages for FICA purposes.[1] This decision was a major victory for the Internal Revenue Service, which has been fighting thousands of refund claims from companies and former employees. Had the Court ruled in favor of Quality Stores Inc., the IRS faced potential refund issuances exceeding one billion dollars.

Quality Stores Inc., an agricultural specialty retailer, closed its stores in 2001 and 2002. The bankrupt company laid-off over 3,000 workers and subsequently paid them "supplemental unemployment compensation." The company paid taxes on this compensation, but then asked for a refund on the employer's and employees' share of the FICA tax, 7.65% each.

The Supreme Court, in an 8-0 decision, found that the severance payments constituted taxable wages under FICA's broad definition -- a statute that taxes "wages" paid by an employer or received by an employee "with respect to employment," to fund Social Security and Medicare benefits. The ruling resolves an inconsistency within the lower courts; the Sixth Circuit's Quality Stores decision was in direct conflict with a Federal Circuit's 2008 decision that severance payments are taxable under FICA.[2]

Pending the Supreme Court's decision, employers in the Sixth Circuit (Kentucky, Ohio, Michigan and Tennessee) filed protective claims for refunds, but in light of this ruling, the IRS will now proceed with denying these claims. For employees, take-home severance will be less because a portion will be withheld to cover the FICA tax. If you have questions concerning your business's payroll taxes, consider contacting a tax attorney for counsel.

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

Required Disclosure under Circular 230:

Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

[1] U.S. v. Quality Stores Inc., et al., No. 12-1408, 2014 WL 1168968 (March 25, 2014).

[2] CSX Corp. v. U.S., et al., 518 F.3d 1328 (Fed. Cir. 2008).