In our February 2014 Information Memo, we suggested that an employer that had paid out severance benefits in 2010 and later years, and paid FICA taxes on such benefits, consider filing protective refund claims based upon a 6th Circuit Court of Appeals decision that held that certain severance benefits were not subject to FICA taxes. In a unanimous decision announced on March 25, 2014, the U.S. Supreme Court overturned the 6th Circuit’s decision and upheld the IRS position that FICA taxes (from the employer and the employee) are due and payable on most severance payments. As a result of this decision, refund claims in connection with payroll taxes paid on severance benefits are not viable.
The high court decision rejected the argument that typical severance payments made to terminated employees could avoid FICA taxation on the same basis as payments from "supplemental unemployment compensation benefit" plans (or "SUB" plan payments). SUB plan payments are explicitly subject to income tax withholding, but are not singled out under the FICA statute. A 1990 Revenue Ruling (Rev. Rul. 90-72) clarified the IRS position on the FICA exemption for SUB plan payments and is the basis for applying the FICA tax to most other severance pay.
The Supreme Court decision did not rule on or question Rev. Rul. 90-72. The Revenue Ruling allows periodic SUB benefits tied to the receipt of state unemployment benefits to avoid FICA taxes. That exemption will remain for payments that meet the narrow definition in the ruling. The broad FICA definition of taxable wages, however, will cover almost all other severance payments to terminated employees.
Therefore, the Supreme Court decision eliminates the availability of refund claims for FICA taxes paid with respect to most severance payments.