The Supreme Court rules severance payments are subject to FICA

BY SALLY P. SCHREIBER, J.D.

In a decision involving over $1 million in FICA taxes paid, the Supreme Court on Tuesday held in an 8–0 decision that severance payments to terminated employees are taxable wages for FICA tax purposes ( Quality Stores, Inc., No. 12-1408 (U.S. 3/25/14)). Justice Anthony Kennedy’s opinion overturned a decision of the Sixth Circuit that the severance payments were not subject to FICA (Quality Stores, Inc., 693 F.3d 605 (6th Cir. 2012), aff’g 424 B.R. 237 (W.D. Mich. 2010), aff’g 383 B.R. 67 (Bankr. W.D. Mich. 2008)). A number of other appellate courts had held that the payments were taxable, notably the Federal Circuit in CSX Corp., 518 F.3d 1328 (Fed. Cir. 2008).

When Quality Stores Inc. entered bankruptcy in 2001, it terminated thousands of employees and paid them severance amounts based on job, grade, management level, and length of employment. It originally treated the payments as wages, withholding income tax and the employee portion of FICA tax and paying its FICA tax liability. Then, it decided to pursue refunds of the FICA tax it had paid. The IRS did nothing in response—it did not deny or allow the claim. Quality Stores then filed a claim in Bankruptcy Court, which it won. On appeal, the Sixth Circuit held that Sec. 3402(o) indicated that that the definition of wages for income-tax withholding purposes does not extend to severance payments, and so, by extension, severance payments also were not subject to FICA withholding. 

In overturning the lower courts, the Supreme Court first examined whether the term “wages” for FICA purposes encompassed severance payments. Wages are defined broadly to include all remuneration paid for employment. Employment is any service performed by an employee for an employer. Service includes not only work actually done but the entire employee/employer relationship. Therefore, the Court found that the severance payments, which varied according to the terminated employee’s position and length of service, were wages.

The court then considered whether Sec. 3402(o) limited the meaning of “wages” for FICA purposes. Quality Stores argued that this provision suggests that severance payments are not wages for income tax purposes and also not for FICA purposes. The company also argued that the heading of Sec. 3402(o), “Extension of withholding to certain payments other than wages,” meant that the unemployment compensation benefits listed were “other than wages.” 

In responding to Quality Store’s argument, the Court found little persuasive weight from the heading of the subsection, pointing out that the heading was not meant to imply that all the payments listed in Sec. 3402(o) were not wages. The Court explained that the history of Sec. 3402(o) showed that it was enacted to solve a limited problem involving income tax withholding and the interaction of employer supplemental unemployment benefits and state unemployment benefits, not to narrow the definition of wages. Therefore, the heading of Section 3402(o) could not be interpreted to mean that all the payments listed in it are not wages.

Having found that severance payments are wages for FICA purposes and that Sec. 3402(o) does not exclude severance payments from wages, the Court held that the severance payments Quality Stores paid to its terminated employees were taxable wages for FICA purposes. The Court remanded the case to the Sixth Circuit for further proceedings consistent with its opinion. 

Sally P. Schreiber ( sschreiber@aicpa.org ) is a JofA senior editor.

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