FICA Maintains Grasp on Severance Payments

FICA Maintains Grasp on Severance Payments

CJ Stroh, Esq.
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Resolving a split among the courts, the Supreme Court has ruled that severance payments are subject to the Federal Insurance Contributions Act (“FICA”). The tax code’s income tax withholding provisions generally define “wages” in substantially the same way that FICA does: all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.

However, in the 2010 court case United States v. Quality Stores, the Sixth Circuit Court of Appeals ruled that severance payments made to involuntarily terminated employees, which were not tied to the receipt of state unemployment, did not fall within FICA’s definition of wages. The Sixth Circuit relied on the language of IRC §3402(o)(1), which provides that supplemental employment benefits (“SUB payments”) are to be treated “as if”  they are payments of wages for income tax withholding purposes. The court reasoned that this language implies Congress did not consider SUB payments to be wages, but instead allows their treatment as such for the purpose of facilitating federal income tax withholding for taxpayers.

Quality Stores contradicted the Federal Circuit’s decision in CSX Corp. v. U.S. (CA Fed Cir 3/6/2008), as well as decisions in both the Seventh and Eighth Circuits, which collectively held that at least some severance payments constitute wages subject to FICA tax.

In analyzing Quality Stores, the Supreme Court held that (i) severance payments fall within FICA’s definition of wages, and (ii) IRC §3402(o) does not change that classification. As an initial matter, the Supreme Court observed that Congress used extremely broad language in defining wages for FICA purposes. In analyzing the plain meaning of the text, the Court stated that severance payments are remuneration, and that employees receive said payments for employment. Additionally, the Supreme Court found support in the specific exemption FICA provides for severance payments that are made “because of… retirement for disability,” opining that this provision would be unnecessary if severance payments were generally excluded altogether.

Furthermore, the Supreme Court rejected the Quality Stores argument that because IRC §3402(o) treats SUB payments “as if” they are wages for withholding purposes, that it also necessarily means severance payments are not FICA wages.

The Court noted that §3402(o)’s treatment of SUB payments is “in all respects consistent with the proposition that at least some severance payments are wages.” Moreover, Quality Stores’ reliance on the heading of §3402(o), which reads “Extension of withholding to certain payments other than wages,” was also insufficient to establish the exclusion of severance payments from wages.

Had Quality Stores been affirmed, the IRS could have been forced to refund the many protective refund claims that had been filed by employers for severance payments made in tax years occurring in and after 2010.

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If you have any questions about this Tax Tip, please contact your WithumSmith+Brown professional, a member of WS+B’s National Tax Services Group or email us at [email protected].

David Springsteen, CPA, MBA
Practice Leader, Tax Services Group
609.520.1188
[email protected]

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