Employment Law Blog

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Apr 02, 2014

Supreme Court rules that severance payments are subject to FICA taxes

 

Severance payments for terminated employees are subject to FICA taxes, as long as the severance isn’t tied to state unemployment benefits, ruled the U.S. Supreme Court today. FICA is the Federal Insurance Contributions Act, which requires workers and employers to pay taxes on wages in order to fund Social Security and Medicare.

Severance payments for terminated employees are subject to FICA taxes, as long as the severance isn’t tied to state unemployment benefits, ruled the U.S. Supreme Court today. FICA is the Federal Insurance Contributions Act, which requires workers and employers to pay taxes on wages in order to fund Social Security and Medicare.

Quality Stores, Inc., had to downsize as part of a bankruptcy proceeding, and terminated thousands of employees. Employees were eligible for severance payments depending on their job level and years of service. The company withheld FICA taxes from the payments but then obtained permission from approximately 1,850 employees to pursue refunds of those taxes. The total value of the requested refund was over $1 million. Not surprisingly, the IRS didn’t pay up.

The Supreme Court said the withholding rules for FICA and income tax should be handled the same way, whenever possible. The parties agreed that the severance payments were subject to income tax withholding, but they disagreed about FICA. Given the broad definition of “wages” under FICA, the Court felt it made sense to say the severance payments are wages, because they are paid to people as a result of their employment with an employer.

The Court noted that some severance programs are set up as “supplemental unemployment benefits” (SUBs) that are intended to boost workers’ pay on top of any state unemployment benefits. The IRS has issued a Revenue Ruling that such payments aren’t subject to FICA taxes. The Court didn’t take a position one way or another on those supplemental unemployment benefits, however, because they weren’t at issue in this case. The Court also noted that FICA itself says some payments made by an employer to workers aren’t subject to FICA taxes, such as “payments on account of disability caused by sickness or accident, cash payments made for domestic service in a private home under a certain amount, and cash tips less than a certain amount.”

For ordinary severance payments, which aren’t tied to the receipt of unemployment benefits, the Court’s decision makes it clear that FICA taxes should be withheld (United States v. Quality Stores, Inc., US, March 25, 2014). If you are in a downsizing situation, or need assistance with resolving potential claims from a departing employee, contact your Vigilant staff representative. We can help you decide whether to offer a release of all claims in exchange for a settlement amount, and we can also draft an agreement to fit the situation.

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