Supreme Court Decision - Some Severance Payments Are Not FICA-Taxable

On March 24, 2014, the US Supreme Court handed down a ruling that stated that severance payments made to involuntarily terminated workers are wages subject to FICA taxes.

Currently there are approximately $1 billion in contested FICA taxes, and now due to this Supreme Court ruling, employers will not be allowed to recover any of these monies.

United Sates Case v. Quality Stores, Inc

In the US’ case against Quality Stores Inc., Supreme Court determined that Quality Stores could not rely on an amendment to withholding provisions in the IRC to exclude all supplemental unemployment benefits from the definition of wages subject to FICA taxation.

In 2001, Quality Stores filed for Chapter 11 bankruptcy and then terminated thousands of employees.  Quality Stores claimed that supplemental unemployment benefits paid to these employees were not subject to FICA taxes because they were not wages or any kind of compensation for services performed.

The US government, specifically the IRS, claimed that the supplemental unemployment benefits were indeed payments for employee services, and were therefore subject to FICA taxes.  The IRS said that more than $1 billion in tax liabilities nationwide was involved in this case.

Supreme Court Decision

In an 8-0 ruling, the Supreme Court voted in favor of the US government, overturning a previous ruling by the Sixth Circuit Court which had said that Section 3402(o) of the IRC exempts severance pay from FICA tax since severance pay is not defined as wages for FICA purposes.

IRC Section 3402(o) says that any severance payment “shall be treated as if it were a payment of wages,” and the Sixth Circuit read the “as if” clause to imply that severance payments are not truly wages, but are still taxable for federal income tax purposes.  However, Justice Anthony Kennedy wrote that the “as if” clause of Section 3402(o) is “consistent with the proposition that at least some severance payments are wages.”  He went on to add, “As the Federal Circuit explained when construing Section 3402(o), the statement that ‘all men shall be treated as if they were six feet tall does not imply that no men are six feet tall.”

According to the Court, Congress intended there to be a broad definition of “wages” under FICA, and it does include payments such as the severance paid by Quality Stores.

The IRS interpretation that supplemental benefits linked to the receipt of unemployment benefits are exempt remains in place, the court said.

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