Supreme Court holds severance payments are subject to FICA

The case resolves a circuit split over the definition of “wages” and excludable severance payments.

In a decision involving over $1 million in Federal Insurance Contributions Act (FICA) taxes paid, the Supreme Court held in an 8–0 decision that severance payments to terminated employees are taxable wages for FICA tax purposes. 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); see previous Tax Matters coverage, Dec. 2012, page 62, and June 2010, page 79). 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).

Facts: 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 not deny or allow the claim.

Quality Stores then filed a claim in bankruptcy court, which it won, and the district court affirmed. On appeal by the IRS, the Sixth Circuit found that the payments under the plans were supplemental unemployment benefit (SUB) payments, and that under Sec. 3402(o), SUB payments were not wages for purposes of income tax withholding. Because wages are defined almost identically for purposes of FICA and income tax withholding, the court concluded that SUB payments should not be treated as wages for FICA purposes.

Issues: The Supreme Court first examined whether the term “wages” for FICA purposes encompasses 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) limits the meaning of “wages” for FICA purposes. Quality Stores argued that the heading of Sec. 3402(o), Extension of Withholding to Certain Payments Other Than Wages, means that the supplemental unemployment compensation benefits described there, including severance payments, are “other than wages.”

In responding to Quality Store’s argument, the Court accorded little persuasive weight to the heading of the subsection, pointing out that the heading was not meant to imply that all the payments listed in Sec. 3402(o) are 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.

Holding: 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.

  Quality Stores, Inc., No. 12-1408 (U.S. 3/25/14)

By Sally P. Schreiber, J.D., a JofA senior editor.