On March 25, 2014, the United States Supreme Court held in United States v. Quality Stores, Inc. that severance payments made to employees who were involuntarily terminated are taxable as wages under the Federal Insurance Contributions Act (“FICA”). United States v. Quality Stores, Inc., U.S., No. 12-1408, (3/25/14). Quality Stores, Inc., an agricultural-specialty retailer, and its affiliates terminated thousands of employees in conjunction with entering bankruptcy proceedings. The terminated employees received severance payments in varying amounts based on their seniority and job function. Quality Stores, Inc. reported the severance payments as wages, paid and withheld the required FICA taxes and then filed for a refund of the remitted FICA taxes. The Bankruptcy Court, District Court and Court of Appeals for the Sixth Circuit all found in favor of Quality Stores, Inc. and concluded that the severance payments were not wages under FICA.
In reversing the lower courts’ decisions, the Supreme Court focused on the expansive definition of wages under FICA and the nature of severance payments. As severance payments stem from the employer-employee relationship, the Supreme Court found that severance payments clearly fell within FICA’s broad definition of wages as “remuneration for employment.” The fact that a specific exemption for certain terminated-related payments exists under FICA (but not the termination payments in question here) and that Congress had explicitly removed an exception from the definition of “wages” for severance payments in the past further supported the Supreme Court’s conclusion.
The Supreme Court also rejected several textual arguments made by Quality Stores, Inc. In refuting Quality Stores, Inc.’s efforts to limit the definition of wages, the Supreme Court recounted the history of the taxation of “supplement unemployment benefits” (“SUBs”) and the relationship of SUBs to state unemployment benefits as reflected in the Code. Moreover, the Supreme Court stated that the decision in Rowan Cos v. United States (452 U.S. 247 (1981)) mandates that the definition of “wages” for purposes of income tax withholding and FICA taxation should be the same for simplicity of administration and consistency of statutory interpretation. Accordingly, as the termination payments here were subject to withholding, the Supreme Court observed that it would violate the principle of the Rowan decision to hold that severance payments are exempt from FICA taxation but not from income tax withholding.
Despite its conclusion, the Supreme Court noted that the Internal Revenue Service still provides that severance payments tied to the receipt of state unemployment benefits are exempt from both income tax withholding and FICA taxation. As severance payments linked to state unemployment benefits were not at issue in the present case, the Supreme Court left open the issue of whether the Internal Revenue Service’s current exemption for these types of severance payments is consistent with the broad definition of wages under FICA. However, given the Supreme Court’s reliance on the consistency principle established in Rowan, it is likely that termination payments linked to state unemployment benefits would also be subject to FICA if that position is asserted by the Internal Revenue Service in the future.