Compensation for services as an employee (called “wages” in the federal tax code) are subject to FICA (social security and medicare) tax as well as income taxes. Over the past 70 years, the courts, including the U.S. Supreme Court, have considered the extent to which severance payments made on account of termination of employment are wages subject to FICA taxes, generally holding that severance payments are subject to FICA tax.
In 2012, however, the Court of Appeals for the Sixth Circuit held that severance payments made to employees whose employment was involuntarily terminated in connection with the employer’s bankruptcy were not “wages” for purposes of FICA tax. In arriving at its decision, the appeals court treated the severance payments as indistinguishable from union-negotiated supplemental unemployment benefits (SUB), which are not “wages” for purposes of income tax withholding (although they are subject to income tax withholding), and extended the income tax definition of “wages” to FICA tax.
On March 25, 2014, in United States v. Quality Stores, Inc., Case No. 12-1408, the Supreme Court reversed the appeals court and held that the severance payments are “wages” for FICA purposes and, thus, subject to FICA tax. In its decision, the Court focused on the broad definition of the term “wages” for FICA purposes, and a narrow statutory exclusion of severance payments made “because of disability.” The Court also noted that severance payments generally fell within the “broad textual definition of wages” for income tax withholding purposes. Finally, the Court attributed the exclusion of SUB from the income tax withholding definition to a quirk intended to allow SUB beneficiaries to simultaneously collect state unemployment benefits.
This case represents another in a series of (unsuccessful) efforts by taxpayers to avoid paying FICA taxes on severance payments, and an affirmation of the long standing rule that, with limited statutory exceptions, such payments are subject to FICA tax.