The U.S. Supreme Court To Determine If Severance Pay Given To Terminated Employees Is Taxable Under FICA

Nicholas Fortuna, October 3, 2013.

The U.S. Supreme Court of the United States will decide if severance payments made to terminated employees are taxable under the Federal Insurance Contributions Act (FICA). The Court of Appeals for the Sixth Circuit determined in U.S. v. Quality Stores, et al. that the severance payments made to terminated employees were not taxable. The Sixth Circuit found that the payments were supplemental employment benefits (SUB) and thereby not taxable under FICA.

FICA tax of employee wages funds the Social Security and Medicare programs. Both the employee and employer pay part of this tax. The employer collects the employee’s share by deducting the tax from wages as they are paid. Generally, FICA tax is paid on severance payments. If the Supreme Court upholds the decision of the Sixth Circuit and finds that the payments are SUBs, it will be a consequential reversal of employer tax liability and entitle employers to tax refunds.

The concept of SUB payments evolved from the demand by organized labor for a guaranteed annual wage. The unions sought employer supplementation of existing state unemployment compensation programs. A number of industries adopted SUB plans. SUB payments are not compensation for work performed, they are payments as a result of an employee getting thrown out of work. SUB payments and severance are similar in that they are both payments for the loss of jobs.

To determine if a payment is a SUB (and not subject to FICA), Congress has delineated five factors to be considered: (1) the amount paid to the employee; (2) whether it was paid pursuant to an employer’s plan; (3) whether it was paid because of an employee’s involuntary separation from employment, regardless if it was temporary or permanent; (4) whether it resulted directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) whether it was included in the employee’s gross income.

The Sixth Circuit found that Quality Stores’ payments met this test and Quality was entitled to a refund of its share of FICA taxes paid on behalf of employees. The Solicitor General of the United States petitioned the Supreme Court to review the Sixth Circuit’s decision. The Supreme Court agreed. A decision is due by June 2014.

There is a lot at stake for the government because the exposure it has to other taxpayers could be enormous. The Obama administration warned that it could amount to $1 Billion in tax refund claims.


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