Supreme Court to Consider Tax Treatment of Severance Payments

By GJ Stillson MacDonnell © Littler Mendelson Oct 3, 2013

The U.S. Supreme Court agreed on October 1, 2013, to consider whether severance payments made to employees who are terminated are subject to Social Security and Medicare payroll (FICA) taxes.

In United States v. Quality Stores, Inc., (6th Circuit, Sept. 7, 2012), the U.S. Court of Appeals for the Sixth Circuit affirmed a district court ruling that severance payments were not wages subject to FICA taxes. The Internal Revenue Service requested review.

By way of background, Quality Stores had made severance payments to terminating employees and all payroll taxes, including FICA, were withheld from such payments. As FICA taxes are matched by the employer, both the employer and the employee paid this tax. After payment, the employer filed for a tax refund on the basis that the severance plan payments were supplemental unemployment benefits (SUB), and as such, were not wages for FICA purposes. Both the district and federal appellate courts, however, found the severance to be SUB payments, reasoning that such payments were not remuneration for services under FICA but rather payments related to the “elimination of employment.” As such, these payments were not subject to FICA although otherwise subject to income taxes. The IRS argued that the Quality Stores severance payments were not exempt from FICA taxes.

In accepting Quality Stores for review, the Supreme Court will have the opportunity to reconcile a conflict within the circuits, as the Federal Circuit in CSX Corp. v. United States, (Federal Circuit, 2008), has taken the contrary position.

What Does This Mean for Employers?

Given the current split in the circuits, Supreme Court review provides an opportunity not only to settle this issue, but also affords certain severance plan sponsors and severance recipients an opportunity to timely file for and receive refunds on FICA taxes paid. Except for filing extensions already granted by the IRS, the earliest current open year for filing a refund claim is for tax year 2010. Pending the resolution of this case, the IRS had indicated that it would grant extensions to file suit to collect on pending refund claims. It is estimated that if the Quality Stores decision is affirmed, it could result in multiple billions of dollars of FICA refunds. At this point, employers that have paid out severance as FICA taxable wages during 2010 or later should consider reviewing those plans and filing protective refund claims.

Pending the Supreme Court decision, employers should continue to withhold and pay FICA taxes on severance payments otherwise taxable for federal income tax purposes.

GJ Stillson MacDonnell is a shareholder and chair of the employment taxes practice group at law firm Littler Mendelson P.C., in the firm's San Francisco office. This article first appeared in the Littler Workplace Policy Institute's DC Employment Law Update. © 2013 Littler Mendelson. Republished with permission. All rights reserved.

Related SHRM Articles:

Supreme Court Faces Variety of Employment Issues in 2013-14 Term. SHRM Online Legal Issues, October 2013

Severance Payments: To Tax or Not to Tax?, SHRM Online Legal Issues, June 2013

IRS May Owe Employers Millions in FICA Refunds, SHRM Online Legal Issues, October 2012

Be Cautious of Ruling that Severance Pay Isn't Subject to FICA, SHRM Online Compensation, April 2010

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