In a case of considerable importance, the U.S. Court of Appeals for the Sixth Circuit ("Court") recently held that severance payments made to employees under an employer's severance plan as a direct result of a reduction in workforce and discontinuance of a plant or operation are not "wages" subject to withholding under the Federal Insurance Contributions Act ("FICA"). United States v. Quality Stores, Inc. (In re Quality Stores, Inc.), No. 10-1563 (6th Cir. Sept. 7, 2012). In so deciding, the Court rejected longstanding Internal Revenue Service ("IRS") rulings on the treatment of supplemental unemployment benefits ("SUB payments") under FICA, as well as a contrary decision by the U.S. Court of Appeals for the Federal Circuit in CSX Corp. v. United States, 518 F. 1328 (Fed. Cir. 2008). Unless the Court's decision is overturned on rehearing or U.S. Treasury regulations are promulgated changing the result, the issue is likely to be resolved by the Supreme Court of the United States.
FICA Taxes on SUB Payments -
Employers in general are required to pay and withhold FICA taxes on "wages," consisting of the following: (1) Social Security, 6.2 percent of which is employer paid and 6.2 percent is employee paid (4.2 percent is employee paid for 2011 and 2012) up to the taxable wage base ($110,100 for 2012); and (2) Medicare, 1.45 percent of which is employer paid and 1.45 percent is employee paid (for 2012). An employer generally pays its portion and withholds the employee's portion from the employee's wages. Historically, SUB payments were instituted under union plans negotiated to ensure annual wage rates following termination of employment by supplementing state unemployment benefits. SUB payments constitute gross income and, therefore, are subject to income tax withholding. There is longstanding IRS guidance stating that SUB payments also are subject to FICA withholding unless the payments meet certain guidelines, including the requirement that the payments are designed to supplement state unemployment benefits. In Quality Stores, Inc., the IRS asserted that the severance payments do not meet those guidelines and, therefore, are subject to both FICA and income tax withholding.
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