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Monday, April 7, 2014

The Supreme Court Rules that Lump Sum Severance Payments are Wages Subject to FICA Taxes

In a much anticipated ruling, the U.S. Supreme Court on March 25, 2014 ruled 8-0 that lump-sum severance payments made to involuntarily laid off workers are subject to FICA taxes. Currently FICA requires workers and employers to each pay a 6.2% Social Security tax on wages earned up to an annual cap as well as a 1.45% Medicare tax on all wages.

In 2001 and 2002, Quality Stores, Inc. closed more than 300 stores and made severance paymets to 3,100 laid off workers. The company paid the disputed FICA taxes and then filed for a refund from the IRS. FICA taxes are also paid by employees, so any refund would have gone to former employees who paid their share of FICA tax. Quality Stores argued that severance payments were not taxable wages under FICA. The IRS had not yet acted on the application for a refund when Quality Stores filed bankruptcy. The Bankruptcy Court ruled that Quality Stores was due a refund. This decision was upheld by the district court and on September 2012, the 6th U.S. Court of Appeals also upheld the decision. The 6th Circuit's opinion, however, was in direct contrast to CSX Corp. v. U.S., a 2008 decision of the U.S. Court of Appeals for the Federal Circuit. This split in authority between appellate circuits prompted the Supreme Court to hear the appeal.

A lot was riding on the IRS's appeal of the 6th Circuit's decision. Quality Stores' and its former employees' refund claims totaled more than $1 million, and an estimated $1 billion in refund claims by other companies were pending. The IRS argued to the Supreme Court that severance payments like those made by Quality Stores are taxable wages as defined by FICA. The justices unanimously agreed, holding that under "FICA's broad definition, these severance payments constitute taxable wages." Had the Supreme Court ruled otherwise, the IRS would have had to pay the pending refunds, and companies (and their ex-workers) would have been free of FICA taxes on lump-sum severance payments for involuntary separation.

Justice Anthony Kennedy wrote the opinion in United States v. Quality Stores, Inc., No. 12-1408. With this issue now settled, employers who pay lump-sum severance payments to laid off workers should take care to withhold FICA taxes and pay them to the IRS.

Please contact Peter C. Kim if you would like to discuss severance payments or any other employment-related matters.

This article is intended for informational purposes only. It is not intended to provide legal advice, and you should not act on the information contained herein without first consulting legal counsel and obtaining advice with respect to your particular issue or problem.