Final ruling will likely influence IRS to deny $1 billion in FICA refund claims to employers across the US.

On March 25, 2014, the US Supreme Court ruled in favor of the Internal Revenue Service (the IRS) in United States v. Quality Stores, Inc., holding that, in most cases, severance payments should be treated as taxable wages and, accordingly, are subject to Federal Insurance Contributions Act (FICA) withholding.

Case Background

Quality Stores involuntarily terminated thousands of employees in connection with bankruptcy proceedings and paid the employees severance based on job grade, management level and years of service. To facilitate Quality Stores’ post-bankruptcy operations, one of the two termination plans utilized in these layoffs required employees to continue to remain employed through a date determined by the employer in order to receive the severance pay. Quality Stores initially treated the severance payments as wages, withheld all applicable taxes, including FICA, and reported the payments on employees’ W-2 tax forms. Several years later, Quality Stores filed FICA tax refund claims with the IRS, relying on language in Section 3402(o) of the Internal Revenue Code (the Code), which provides that a severance payment “shall be treated as if it were a payment of wages” for purposes of income tax withholding. The Sixth Circuit agreed with Quality Stores that the inclusion of “as if” in Section 3402(o) of the Code demonstrated that the general Code definition of “wages” did not include severance payments and therefore, similarly, the analogous definition of “wages” for FICA tax purposes also does not include severance payments.

Supreme Court Reversal

The Supreme Court reversed this Sixth Circuit decision, broadly interpreting the FICA definition of “wages” in Section 3121 of the Code to encompass any remuneration for employment (other than very specific enumerated exceptions). The Supreme Court held that the variation in severance pay amounts — which rewarded loyalty as they were based on position and seniority — supported the conclusion that the Quality Stores severance payments were, in fact, remuneration for employment, akin to bonuses, stock options or other benefits that employers provide to employees in addition to salary payments. The Supreme Court further held that the “as if” language in Section 3402(o) of the Code was not a limitation on the definition of “wages” for FICA purposes. The Court found that the statutory history of that Code provision demonstrated that the severance payments would only have been exempt from FICA taxes if they had been designed to supplement state unemployment benefits and were actually tied to such benefits.


In the wake of the Sixth Circuit’s holding in Quality Stores, employers filed an aggregate of over $1 billion in FICA refund claims with the IRS. In light of the Supreme Court’s decision, the IRS will now likely deny those claims.

Most employers have treated severance benefits as wages. Following this decision, they should continue to do so, and should withhold FICA taxes from severance payments, unless the severance arrangements are tied to the receipt of state unemployment benefits. Employers who have not treated severance payments as wages subject to FICA tax withholding may now face penalties and/or interest. Such employers should change their practices for future severance payments in light of the Quality Stores decision.