On March 25, 2014, the Supreme Court ruled 8-0 in favor of the government in the long-running Quality Stores litigation, holding that severance payments are taxable FICA wages, even if they fall within the category of supplemental unemployment compensation benefits (“sub-pay”) that are not subject to income tax withholding under Code section 3402(o). We previously discussed Quality Stores in a blog post and a client alert.
Quality Stores faced financial difficulties in 2001, and it eventually entered bankruptcy proceedings. Both before and after filing its bankruptcy petition, the company offered its employees a series of severance packages, payable upon the employees’ separation from the company. The amount of the payments depended on the employees’ positions in the company and their years of service. The payments were not tied in any way to the receipt of state unemployment benefits.
There was no question that the severance payments constituted income under the income tax, or that Quality Stores was required to withhold a portion of the payments for income tax purposes. The only issue was whether the payments constituted “wages” for purposes of FICA. The Sixth Circuit – affirming the judgments of the bankruptcy court and the district court– held that they were not, creating a split among the circuits.
Justice Kennedy’s unanimous opinion for the Court reversed that decision. The Court held that the “plain meaning” of the statute, as well as its legislative history, contradicted the Sixth Circuit in its reading of Section 3402(o). Congress’s intent in enacting Section 3402(o) had been to declare that, regardless whether a particular SUB payment is tied to state unemployment compensation, the employer must withhold on the payment – and treat the payment “as if” it constitutes wages, whether or not it actually does so under the IRS’s various Revenue Rulings.
Interestingly, the Court concluded its opinion with a paragraph alluding to the arguable inconsistency in the IRS’s position. In several Revenue Rulings, the IRS ruled that certain SUB payments that are linked to state unemployment benefits are not subject to FICA. The Court did not reach the question whether the IRS’ current exemption is consistent with the broad definition of wages under FICA. Those Revenue Rulings may now be vulnerable, especially given the Court’s broad reading of “wages” in Quality Stores. But, given the difficulty of establishing standing to challenge the tax exemptions of other taxpayers, it is not likely that this question will be answered by the Court anytime soon.