Reversing a decision of the Sixth Circuit Court of Appeals, the Supreme Court ruled on March 25, 2014 that severance payments to involuntarily terminated employees in connection with a reduction in force are subject to FICA taxes. United States v. Quality Stores, Inc., No. 12-1408. The Court found that FICA’s broad definition of “wages” clearly includes such severance payments.
Quality Stores was an agricultural retailer that terminated thousands of employees in the early 2000s, following bankruptcy proceedings. The terminated employees received severance pay according to their job classifications and, for some, their years of service. Quality Stores paid the employer’s required share of FICA taxes and withheld employees’ share of FICA taxes on the severance payments. However, it challenged the applicability of FICA to the payments by filing a timely FICA tax refund claim.
Quality Stores’ main argument was that certain language regarding “supplemental unemployment benefits” (SUBs) in the Internal Revenue Code’s rules for income tax withholding indicate that the definition of wages does not include severance payments. The Supreme Court disagreed in large part because the SUBs language in the income tax withholding rules was designed to address the taxation of certain benefits that are designed to coordinate with, and are actually tied to, state unemployment benefits. The severance payments in Quality Stores were not tied to state unemployment benefits and therefore were wages. The Court expressed that it was not addressing whether SUBs should remain exempt from FICA.
Employers who have filed FICA refund claims for severance payments based on the Sixth Circuit’s decision should expect such claims to be rejected by the IRS.