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Supreme Court: Severance is FICA-taxable

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in Compensation and Benefits,Human Resources

The U.S. Supreme Court on March 25 unanimously ruled that severance pay is subject to withholding of FICA taxes, which employers and employees pay to fund Social Security and Medicare.

Takeaway: This decision makes clear that employers should withhold FICA taxes from most severance payments. Make sure your payroll department understands this the next time you offer severance pay.

The case—U.S. v. Quality Stores, Inc. (No. 12-1408, U.S. S.Ct., 2014)—settled a tax code question that has long confounded payroll and HR professionals: When exactly do severance payments constitute “wages” for purposes of the Federal Insurance Contributions Act?

Quality Stores, an agricultural products retailer, filed for bankruptcy in 2001, laying off thousands of employees. All were offered severance packages. Some employees received payments on an installment schedule pegged to regular paydays. Others received lump-sum payouts. The company withheld FICA taxes from the payments.

Later, Quality Stores sued, seeking a FICA tax refund totaling over $1 million. As legal proceedings heated up, the government and the company agreed that the payments qualified as what the tax code calls supplemental unemployment benefit pay, or SUB pay.

SUB pay isn’t wages, but it is taxable, and employers must withhold income taxes from SUB pay, as if it were wages. However, for SUB pay to be excluded from FICA, it must be tied to the receipt of unemployment benefits and employees can’t receive it in lump sums. (None of Quality Stores’ former employees collected unemployment benefits.)

In 2012, the 6th Circuit Court of Appeals ruled that, since SUB pay was only treated as if it were wages, it wasn’t taxable for FICA. The federal government appealed the court’s order to issue a refund.

The Supreme Court reversed, ruling that Quality Stores’ severance payments “are taxable wages for FICA purposes.”

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