Supreme Court: Severance payments subject to FICA
Posted On: 3-28-2014 | Posted By: WK Staff
In a ruling issued on March 25, the U.S. Supreme Court upheld the Internal Revenue Service’s argument in United States v. Quality Stores Inc. that severance payments to workers who are involuntarily laid off constitute a form of wages and are subject to Federal Insurance Contributions Act (FICA) tax. The ruling means employers should withhold and remit FICA tax, which covers both Social Security and Medicare, from severance payments.
Quality Stores, Inc., which filed for bankruptcy in 2001 and laid off its workforce, had cited a section of the tax code that seemed to indicate “supplemental unemployment benefits (SUB)” are exempted from income taxes. A lower court previously ruled that severance payments were not wages and therefore not taxable, but the Supreme Court dismissed this approach by indicating the payments “squarely fall within the broad textual definition of wages for purposes of income-tax withholding.” The Supreme Court decision is final and all U.S. courts will now follow suit.
Had Quality Stores prevailed, the IRS would have been forced to refund the company and its employees FICA taxes totaling almost $1 million. Assuming additional refund claims by other employers and employees, the IRS said the impact to the federal government could have been almost $1 billion.
Employers should note that severance payments tied to receipt of state unemployment benefits have been and continue to be exempt from income taxes. The Supreme Court ruling did not impact that exemption.
Should you have any questions regarding the ruling or other aspects of taxable wages, please contact your WK advisor at (573) 442-6171 or (573) 635-6196.
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