(HR) Supreme Court Clarifies that Severance Payments are Taxable

On Tuesday, March 25, 2014, the U.S. Supreme Court, in U.S. v. Quality Stores, Inc., Case No. 12-1408, unanimously ruled that severance payments made to employees who were involuntarily terminated are taxable wages under the Federal Insurance Contributions Act (FICA). The decision overturns a previous ruling from the Sixth Circuit Court of Appeals in favor of Quality Stores which was seeking a $1 million tax refund from the IRS based on its claim that severance payments were not covered by FICA.

Under the Internal Revenue Code (the Code), a SUB payment is any payment that is (i) paid to an employee, (ii) paid pursuant to an employer plan, (iii) paid as the result of an employee’s involuntary separation from employment, (iv) paid as a result of a reduction in force, the discontinuance of a plant or operation, or other similar conditions, and (v) includible in the employee’s gross income.

FICA taxes must be withheld from “wages” paid to employees for services performed, while federal income tax must be withheld from wages and certain other payments to employees. The FICA tax law defines “wages” as “all remuneration for employment” for both income tax withholding and FICA tax withholding. A specific Code provision further provides that, for federal income tax withholding purposes, SUB payments are treated “as if” they are wages. The “as if” language led many taxpayers to argue that, although federal income tax withholding was required from SUB payments, FICA tax withholding was not required because the SUB payments are not actually wages, just treated as wages for income tax withholding.