Possible FICA Tax Savings on Severance Pay

[author: Angela Bohmann]

A recent Sixth Circuit Court of Appeals decision concluded that severance pay provided to employees as a result of layoff or discontinuance of a plant, operations or other similar condition is exempt from FICA taxes. According to the court of appeals, it does not matter whether the severance is paid in a lump sum or in installments, nor does it matter whether the individual is eligible for state unemployment compensation benefits. This case upheld a decision from the Western District of Michigan about which I wrote in 2010.

This decision is quite technical in its reading of the applicable statutes and conflicts with a 2008 decision of the Federal Circuit Court of Appeals. The decision also conflicts with IRS revenue rulings and private letter rulings that interpret the FICA exclusion for what are called supplemental unemployment benefits or SUB benefits. According to the IRS, FICA-exempt SUB payments must be made on account of layoff, plant closure or similar event; must be paid in installments; and must be paid only to individuals eligible for state unemployment compensation benefits. Only the first of those criteria was required by the Court of Appeals.

Because two circuit courts have now reached different conclusions about the FICA taxation of severance pay, it is possible that the Supreme Court will review the decision. If it does not, it seems likely that the IRS will accept the decision only for employers in the Sixth Circuit. However, those employers can take advantage of the decision and file for FICA tax refunds on severance pay. Employers in other circuits might also consider similar action and either bring their own lawsuit challenging the IRS’s position if the IRS does not grant a refund or hope that their claim is still pending if some other employer is successful in a challenge.