Tax

Supreme Court Rules Severance Payments Subject to FICA Taxes

March 2014
Author:  Robert Conner

Robert Conner

Director

Tax

Health Care
Manufacturing & Distribution

1801 California Street, Suite 2900
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On March 25, the U.S. Supreme Court unanimously held that severance payments paid to involuntarily terminated workers of Quality Stores, Inc. were subject to Federal Insurance Contributions Act (FICA) taxes. This reverses a previous ruling by the 6th U.S. Circuit Court of Appeals.

The Supreme Court explained that FICA defines "wages" as all remuneration for employment, and the term “employment” encompasses any service, of whatever nature, performed by an employee for the employer. Under this definition, severance payments made to terminated employees are “remuneration for employment” and are, therefore, generally subject to FICA tax. The IRS still pro­vides that severance payments tied to the receipt of state unemployment benefits are exempt from FICA taxation. 

The Court concluded that Quality Stores, Inc. severance payments were made to employees terminated against their will, were varied based on job seniority and time served and were not linked to the receipt of state unemployment benefits. Under FICA’s broad definition, these severance payments constitute taxable wages. The judgment of the 6th U.S. Circuit Court of Appeals has been reversed, and the case has been remanded for further proceedings consistent with this opinion.

In light of this decision, employers who filed protective refund claims to recover FICA taxes on severance payments no longer have a valid claim and will not be entitled a refund. Furthermore, employers who did not withhold FICA tax on severance pay in reliance on the 6th Circuit decision should evaluate whether an amended Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return, is required to remit the unpaid tax.

To learn more about how this decision applies to severance payments made by your company, contact your BKD advisor.

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