The Sixth Circuit Splits From the Federal Circuit and Rules That Severance Payments Are Not Taxable as FICA Wages


On September 7, 2012, the Sixth Circuit held that certain types of severance payments (referred to as supplemental unemployment compensation or “SUB payments”) are not taxable wages under FICA. United States v. Quality Stores, Inc., No. 10-1563 (6th Cir. 2012). In so holding, the court declined to follow IRS revenue rulings and also declined to follow the Federal Circuit’s contrary decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

FICA imposes employment tax on the amount of “wages” paid to employees with respect to their employment. The definition of “wages” provided in FICA does not directly address SUB payments. SUB payments, however, are provided for under § 3402(o), which defines such payments by reference to a 5-part test and classifies them as payments “other than wages” for purposes of income tax withholding. In Rev. Rul. 90-72, 1990-72 C.B. 211, the IRS announced that it would not follow the definition in § 3402(o) for FICA purposes but would instead enforce the IRS’s own 8-part test, derived from Rev. Rul. 56-249, 1956-1 C.B. 488, to determine whether the payments qualified as wages for FICA purposes. The payments in Quality Stores did not meet the 8-part test (because some benefits were paid in a lump sum, and because all benefits were not linked to the receipt of state unemployment compensation), but did meet the 5-part test of § 3402(o).

Quality Stores paid the FICA tax attributable to the payments made to its laid-off employees, and filed claims for refund. In an adversary proceeding, the Bankruptcy Court for the Western District of Michigan held that the payments were not subject to FICA. The district court affirmed. The Sixth Circuit affirmed the bankruptcy court.

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