Supreme Court Rules Severance Payments Are Taxable

By: Thomas P. Brady

In an October 13, 2012 Labor & Employment Update, we discussed the Sixth Circuit's decision in United States v Quality Stores, Inc., 693 F3d 605 (CA 6, 2012), where the court affirmed the district court's holding that severance payments made to involuntarily terminated employees were not classified as wages for Federal Insurance Contributions Act (FICA) purposes.  On March 25, 2014, the United States Supreme Court reversed the Sixth Circuit's Quality Stores decision.  The Court held that the severance payments made by Quality Stores were taxable wages for purposes of FICA.

In Quality Stores, the company commenced a voluntary Chapter 11 bankruptcy case.  As part of the bankruptcy, Quality closed a number of stores and distribution centers.  This led to a termination of all its employees.  Quality developed two severance plans, the pre-petition plan and the post-petition plan.

The pre-petition plan was based on job grade, management level, and the number of months or weeks employed by Quality.  The severance payments were not tied to the receipt of state unemployment compensation and were not attributable to the provision of any particular services by the employees.  The payments were made on the normal payroll schedule.

The post-petition severance plan was designed to encourage employees to remain with the company by assuring them severance pay if their jobs were eliminated.  Employees were eligible for severance pay if they completed the last day of service as scheduled.  The post-petition severance amounts were not tied to the receipt of state unemployment compensation and were not attributable to the employee providing any particular service.

Quality reported the payment of severance as wages and withheld both the employer's and employee's share of the FICA taxes. However, Quality took the position that the severance payments were SUB Plan payments.  It argued that the IRS should refund the FICA payments because SUB Plan payments were not taxable wages under FICA.  When the IRS rejected this argument, Quality brought an adversary action in the bankruptcy court.  The bankruptcy court, the district court and the Sixth Circuit Court of Appeals found that the severance payments were SUB Plan payments and not wages subject to the FICA tax.

The Supreme Court, on appeal, held that severance payments were remuneration to the employee and therefore wages under FICA's broad definition of the term "wages". It also found that the Internal Revenue Code chapter governing wages did not limit the meaning of "wages" for FICA purposes.  The Court concluded that the severance payments made by Quality constituted taxable wages for which FICA payments were due.

The Supreme Court's decision reversing the Sixth Circuit's decision means that employers who provide severance pay to employees must pay FICA taxes on, and withhold the employee's FICA portion from, severance pay.

If you have any questions about FICA payments on severance benefits, under the Internal Revenue Code, please contact Thomas P. Brady at (313) 965-8291 or eat0@eau0eav0eaw0; Ed Hammond at (248) 988-1821 or eat1@eau1eav1eaw1; or another member of Clark Hill's Labor and Employment Practice Group.