The Employer's Legal Resource: Supreme Court Rules Severance Pay Subject to FICA Tax
Quality Stores, as part of their bankruptcy, made severance payments to terminated employees, which varied based on job seniority and time in service. As part of the payments, Quality Stores withheld a portion for income taxes (Withholding) and also the percentages indicated under the Federal Income Contributions Act (FICA), which for most employees was the 6.2% for Social Security and the 1.45% for Medicare we are all familiar with. Quality Stores also contributed the Employer's share as provided in FICA.
Quality Stores later believed that the FICA taxes were improperly paid, both on behalf of the company and the terminated employees and sought a refund from the IRS, which was denied. Quality Stores won their case in both Federal District Court and the Sixth Circuit, but the Supreme Court was not as taxpayer friendly.
FICA defines "wages" as all remuneration for "employment," which is "any service.. performed... by an employee for an employer. Since the payments were varied by the terminated employee's function and seniority, they were found to be related to "service," which includes not only work actually done, but the reflecting the entire employee-employer relationship for which the compensation was paid.
All "wages" are subject to FICA tax, unless an exemption exists (e.g. there is one for "retirement for disability"). Since no exception existed, the Supreme Court found that FICA tax was properly paid.
In 1939, Congress had exempted "dismissal payments" from "wages," but that provision was repealed in 1950, such that there has been no FICA exception for severance payments since then.
The Court also relied upon the concept of keeping the definition of "wages" for both withholding and FICA a consistent one, unless the tax statutes clearly provide otherwise.
The Court also noted (in passing) that the IRS still provides (Revenue Ruling 90-72) that severance payments tied to the receipt of state unemployment benefits (as in some union Supplemental Unemployment Benefit plans) are exempt from withholding and FICA. The payments here were not so tied. The correctness of the IRS' exemption was not before the Court.
Justice Kennedy wrote the opinion for the unanimous Court, although Justice Kagan did not participate, presumably because she was Solicitor General of the United States during the time the case was pending in the lower courts.
By Harry V. Rouse, email@example.com