Supreme Court Decides Severance Not Exempt From FICA


Executive Summary:  On March 25, 2014, the United States Supreme Court unanimously held that certain severance payments (described as "supplemental unemployment compensation benefits" or "SUBs") constituted taxable wages for purposes of FICA.  See United States v. Quality Stores, Inc.  No. 12-1408 (2014).  The Sixth Circuit had held that the payments were not wages subject to FICA, in a decision from which the IRS appealed.  See In re Quality Stores, Inc., 693 F. 3d 605 (6th Cir. 2012).

The Federal Circuit had previously held that similar payments were wages for purposes of FICA, in CSX Corp. v. United States, 518 F. 3d 1328 (Fed.Cir., 2008). The Sixth Circuit decision created a conflict that needed to be resolved by the Court.

The Supreme Court's decision was primarily based upon the actual definitions contained in the Internal Revenue Code, specifically sections 3121(a) and (b), which define the terms "wages" and "employment," respectively, for FICA purposes, as well as prior Court decisions such as Social Security Board v. Nierotko, 327 US 358 (1946) (holding that "service" includes not only work actually done but the entire employer-employee relationship for which compensation is paid to the employee by the employer) and Rowan Cos. v. United States, 452 US 247 (1981) (holding that "wages" should generally be defined the same way for income tax withholding and for FICA purposes). The Court also rejected the taxpayer's argument that section 3402(o) of the Code, which provides that "supplemental unemployment compensation benefits" are treated for income tax withholding purposes "as if they were wages," means that they are not wages; rather, the Court found that section 3402(o) was enacted in order to deal with a specific income tax issue, and did not affect the payments' characterization for purposes of FICA.

The Court's decision, written by Justice Kennedy, holds that the severance payments in question, which were (i) made to employees who were involuntarily terminated, (ii) subject to variation based on seniority, and (iii) not conditioned on or linked to the employees' receipt of state unemployment benefits, and which the parties had stipulated qualified as SUBs, constituted taxable wages according to the broad definition used for purposes of FICA. The decision also states that it does not address whether Rev. Rul. 90-72, which deals with payments that are tied to state unemployment benefits, is consistent with the broad definition of wages under FICA.

This was a big-dollar (although generally anticipated) win for the IRS, as over $1 billion of potential FICA refunds – for both employers and employees – was on the line. In addition, it would have changed the future taxation of severance pay, perhaps substantially, at least until a legislative "fix" could be accomplished (if at all).  This should be the final answer as far as severance payments that fall outside the limited exception of Rev. Rul. 90-72 are concerned – they are subject to FICA (and FUTA) taxes, as well as income tax withholding.  Accordingly, any prospective claims or other pending refund claims will be denied.

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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