The Sixth Circuit’s recent decision in United States of America v. Quality Stores, Inc., held that severance payments paid by a bankrupt company to its former employees were supplemental unemployment compensation benefit (SUB) payments that did not constitute “wages” for FICA purposes. As a result, the severance payments were not subject to FICA taxation. Employers located in the Sixth Circuit (Kentucky, Ohio, Michigan and Tennessee) who have made similar payments should seek a refund of FICA taxes paid. Employers located elsewhere should consider filing protective refund claims. All employers should consider whether to withhold and pay FICA taxes for future payments paid in connection with workforce reductions. Before taking any action, employers should consult with an experienced attorney to determine the best way to structure future payments and/or seek a refund of past FICA tax payments.


Quality Stores was the largest agricultural-specialty retailer in the country. In 2001, Quality Stores filed for bankruptcy, ultimately closing all of its stores and firing all of its employees. Quality Stores made severance payments under two plans to employees whose employment was involuntarily terminated. In general, the employees received one week of severance pay for each year of service, and the payments were not tied to the receipt of state unemployment compensation. Quality Stores withheld the employee’s federal income tax and FICA taxes, paid the employer’s share of FICA tax, and reported the severance payments as wages on Form W-2. In 2002, Quality Stores filed for a refund of over $1 million of FICA taxes paid. The refund claim included the employer’s share of FICA, and the employee’s share of FICA for those employees who consented to permit the company to make the refund request for them.

The IRS’s position, as stated in a series of rulings, is only severance payments that satisfy the IRS’s administrative definition of SUB payments are exempt from FICA withholding. The payments in question made by Quality Stores did not meet this definition because they were not tied to state unemployment compensation, and some of the payments were paid in a lump-sum. Quality Stores took the position that the IRS’s administrative definition was incorrect, and asserted that what governed was the broader definition of SUB payments set forth in Section 3402(o)(2)(A) of the federal tax code.

Sixth Circuit’s Decision (September 7, 2012)

The Sixth Circuit agreed with Quality Stores, finding that the severance payments at issue fell within the Section 3402(o)(2)(A) definition of SUB payments. The Court then held that as SUB payments, the severance payments were not “wages” for purposes of FICA.

The Court found that a payment qualifies as a SUB payment within the meaning of Section 3402(o)(2)(A) if the payment meets the following 5 statutory requirements:

  • an amount paid to an employee;
  • pursuant to an employer’s plan;
  • because of an employee’s involuntary separation from employment, whether temporary or permanent;
  • resulting from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and
  • includible in the employee’s gross income.

(Emphasis added). The Court expressly rejected the more narrow definition of SUB payments set forth by the IRS in its rulings. The Court noted that IRS rulings do not have the force of law, and found that the rulings conflict with Congressional intent.

The Sixth Circuit’s decision is in direct conflict with the Federal Circuit’s 2008 decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), which held that payments similar to the ones in Quality Stores were not SUB payments after applying the IRS’s administrative definition of SUB payments rejected in Quality Stores. The Court in Quality Stores stated that Congress should clarify the statutes concerning the imposition of FICA tax on severance payments, and acknowledged that the circuit conflict may ultimately have to be resolved by the Supreme Court.


Note that this case serves as precedent only to parties residing in the Sixth Circuit (Kentucky, Ohio, Michigan and Tennessee). Pending further developments, if severance payments qualify as SUB payments, employers located in the Sixth Circuit should not withhold or pay FICA taxes. Additionally, these employers should claim a refund for all open years for FICA taxes already paid. Employers located outside of the Sixth Circuit may want to consider not withholding or paying FICA taxes going forward, and may choose to file protective claims for years not precluded by the statute of limitations. Regardless of where located, employers should consult their attorneys regarding whether payments under their severance payment arrangements qualify as SUB payments.