Uncle Sam Still Wants Your Money – Supreme Court Rules that Severance Payments are Wages for Tax Purposes

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Uncle Sam Still Wants Your Money – Supreme Court Rules that Severance Payments are Wages for Tax Purposes

3/12/15

In order to fund the benefits provided by the Social Security Act and Medicare, the Federal Insurance Contributions Act (“FICA”), 26 U.S.C. § 3101 et seq., taxes “wages” paid by an employer or received by an employee “with respect to employment.” The United States Supreme Court recently held that, as a general rule, severance payments that are not tied to state unemployment benefits, are “wages” for purposes of FICA. Accordingly, employers offering employees severance packages in connection with their termination must be sure to report any severance payments as wages, pay the employer’s portion of FICA taxes, and withhold the employee’s share.

In United States v. Quality Stores, Inc., 134 S.Ct. 1395 (2014), Quality Stores, an agricultural specialty retailer, terminated thousands of employees in connection with it filing for Chapter 11 bankruptcy in 2001. Quality Stores paid its employees severance pay as a result of the layoffs, and reported the payments as wages under FICA. Later, Quality Stores applied for a refund of over $1 million in FICA taxes, claiming that they were not owed under FICA. When the IRS did not return the money, Quality Stores initiated an action in the Bankruptcy court seeking the refund. The Bankruptcy Court, District Court, and Sixth Circuit Court of Appeals all agreed with Quality Stores that the severance payments were not “wages” for purposes of FICA. The Supreme Court, however, disagreed.

The Supreme Court, looking first at the language of FICA, noted that FICA defines “wages” broadly to include “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” Because severance is only paid to employees, the Supreme Court concluded that it must be considered “remuneration for employment.” The Supreme Court further noted that severance was not included in the extensive list of exemptions from the definition of “wages” in the FICA – which includes an exemption for severance payments made due to disability — but that the legislative history demonstrated that Congress had initially included an express exception for it.

Based upon the Supreme Court’s ruling in this case, most severance payments will be treated as “wages” for purposes of FICA taxes. Accordingly, employers should generally pay the employer’s portion of FICA taxes and withhold the employee’s share.

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