Is There Quality to the Argument That Severance Payments Are Not Taxable "Wages"? – Supreme Court Holds That Severance Payments Are Subject to Social Security Taxation

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Earlier this week, on March 25, 2014, the U.S. Supreme Court handed down a highly publicized decision in the case of United States v. Quality Stores. In Quality Stores, the Court unanimously held that the severance payments at issue in the case are taxable "wages" for purposes of the rules governing Social Security taxation under the Federal Insurance Contributions Act (“FICA”).

In Quality Stores, an employer made severance payments to a number of employees in connection with the employer's bankruptcy proceedings. The severance payments were made to employees being involuntarily terminated. The payments varied based on the employees' respective seniority and were not linked to the receipt of state unemployment benefits. The employer paid its portion of Social Security taxes on the severance payments and also withheld the employees' portion of such taxes. Subsequently, on behalf of itself and various employees, the employer sought a refund of both its own payments and the amounts withheld from employees. The employer argued, based on asserted implications arising out of certain statutory provisions, that the severance payments should not be considered taxable "wages" for FICA purposes.

The bankruptcy court, the district court and the Court of Appeals for the Sixth Circuit all held in favor of the employer, concluding that severance payments of the type at issue are not taxable "wages" under FICA. As a result of these decisions, and in particular the Sixth Circuit decision, some employees who have been paid severance, and their employers, have chosen to file protective refund claims with the Internal Revenue Service to preserve their rights to obtain refunds of Social Security taxes, in the event that ultimately it would be determined that severance payments are generally not "wages" for FICA purposes.

Resolving a conflict in the circuit courts resulting from the Sixth Circuit's decision, the Supreme Court has now unanimously rejected the employer's contention in Quality Stores, and held that the disputed severance payments are taxable wages. For those taxpayers who have all along been treating severance payments as being "wages" for FICA purposes, Quality Stores would generally not be expected to have significant practical impact. For those taxpayers who have filed protective refund claims on the basis of the reasoning of the Sixth Circuit decision, those claims will presumably be rejected (if not withdrawn). If there are any taxpayers who have otherwise been proceeding on the basis that severance payments are not "wages" for FICA purposes, those taxpayers should consider reexamining that approach. It is noted that there continue to be open issues regarding the proper treatment of severance payments that, unlike the payments in Quality Stores, are tied to state unemployment benefits under a so-called "SUB" plan.

Topics:  FICA Taxes, Income Taxes, Quality Stores, SCOTUS, Severance Agreements, Wage and Hour

Published In: Labor & Employment Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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