The U.S. Supreme Court ruled on March 25, 2014, that severance payments made to employees terminated against their will are taxable wages under the Federal Insurance Contributions Act (FICA).
In a decision with far-reaching implications, the court voted 8-0 to overturn a Sixth Circuit opinion that Quality Stores' severance payments to its former employees were not wages and, thus, were not taxable under FICA.
Quality Stores, Inc., an agricultural-specialty retailer, declared bankruptcy in 2001 and made severance payments to thousands of employees who were involuntarily terminated as part of Quality Stores' Chapter 11 bankruptcy. Quality Stores paid, and withheld, taxes required under FICA. After later coming to believe that the payments should not have been taxed as wages under FICA, Quality Stores sought a refund on behalf of itself and several former employees. The Internal Revenue Service (IRS) declined to either allow or deny the refund. Quality Stores then initiated proceedings in the Bankruptcy Court, which granted summary judgment in Quality Stores' favor. The District Court and the Court of Appeals for the Sixth Circuit affirmed.
In reversing, and concluding that the severance payments at issue are taxable wages for purposes of FICA, the high court focused on the broad definition of "wages" and the historical treatment of severance pay. The Supreme Court noted that Congress chose to define wages under FICA "broadly." Specifically, FICA defines "wages" as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash." The term "employment" encompasses "any service, of whatever nature, performed … by an employee for the person employing him." The Court explained that, under this definition, and as a matter of plain meaning, severance payments made to terminated employees are "remuneration for employment." The Court further explained that severance payments are made to employees only, and that "[i]t would be contrary to common usage to describe as a severance payment remuneration provided to someone who has not worked for the employer."
The court dismissed Quality Stores' contention that its severance payments were exempt from FICA taxation under the supplemental compensation benefits (SUBs) definition in the Internal Revenue Code. In doing so, the Court explained that the relevant chapter of the code governing income tax withholding has a broad definition of the term "wages," and that the definitional section for income-tax withholding, like the definitional section for FICA, contains a series of specific exemptions that reinforce the broad scope of its definition of wages.
The Court's ruling may be viewed as a triumph for the government, effectively rendering all existing (or contemplated) claims invalid. As noted in the petition for a writ of certiorari, the unknowns surrounding the treatment of severance payments had resulted in 11 similar cases and more than 2,400 administrative refund claims, with a total amount at stake of more than $1 billion.