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U.S. Supreme Court Grants Certiorari to Dispute Over FICA Treatment of Severance Pay

November 15, 2013

Dina M. Ouellette, CPA
Tax Director

The U.S. Supreme Court has agreed to resolve a split among the circuit courts of appeal on the FICA tax treatment of severance pay. The Supreme Court announced that it will review In re Quality Stores, 2012-2 ustc ¶50,551, in which the Sixth Circuit Court of Appeals found that supplemental unemployment benefits (SUB) payments are not wages for purposes of FICA taxation. As a result of the Sixth Circuit's decision, there is now a lack of uniformity among circuit courts on the question of whether severance pay is subject to FICA taxes.

Factual Background of Quality Stores

The taxpayer operated a chain of retail stores. After its business slowed down, the taxpayer closed many of its stores and terminated some employees. Business did not rebound, and the taxpayer eventually sought bankruptcy protection. All of its remaining employees were discharged.

The taxpayer made severance payments under two separate plans to the employees whose employment was involuntarily terminated. Under the terms of the Pre-Petition Severance Plan, severance pay was based on job grade and management level in the organization. The Post-Petition Severance Plan was designed to encourage employees to defer their job searches and dedicate their efforts and attention to the company by assuring them that they would receive severance pay if their jobs were eliminated. Under the Post-Petition Severance Plan, on average, salaried employees received 5.2 weeks of severance pay, while hourly employees received 3.1 weeks of severance pay.

The taxpayer reported the payments as wages on Forms W-2, withheld federal income tax, paid the employer's share of FICA tax and withheld each employee's share of FICA tax. However, the taxpayer subsequently requested refunds of the FICA taxes, taking the position that the payments were SUB payments and exempt from FICA taxation. The Sixth Circuit ruled in favor of the taxpayer, and the government petitioned the Supreme Court to review the case.

Circuit Split

In the earlier case CSX v. U.S., 2008-1 ustc ¶50,218, the Federal Circuit had followed the IRS's approach outlined in Rev. Rul. 90-72. In this case the IRS had determined that SUB payments would generally be subject to FICA taxes. However, the Sixth Circuit was not persuaded by Rev. Rul. 90-72.

Sixth Circuit's Decision

The Sixth Circuit first found that a SUB payment is an amount paid to an employee; under an employer's plan; because of an employee's involuntary separation from employment, whether temporary or permanent; resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and included in the employee's gross income the court found that the payments made by the taxpayer satisfied these requirements. The Sixth Circuit noted that SUB payments do not need to be tied to an employee's receipt of state unemployment compensation benefits, nor is there any distinction between periodic payments or one-time payments made in a lump sum.

The Sixth Circuit further found that Congress has defined wages for FICA purposes, with certain exceptions, as being all remuneration for employment, including the cash value of all remuneration. Employment means any service performed by an employee for the person employing him or her. The definition of wages for federal income tax withholding, the court found, is nearly identical to the definition of wages for FICA purposes.

Additionally, the Sixth Circuit found that Congress has expressly provided that any payment that meets the statutory definition of a SUB payment is treated as if it were a payment of wages. According to the court, Congress did not consider SUB payments to be wages but allowed their treatment as wages to facilitate federal income tax withholding. The Sixth Circuit concluded that the payments the taxpayer made (under the pre- and post-petition plans) were SUB payments.

It should be noted that the Sixth Circuit covers Kentucky, Michigan, Ohio and Tennessee.   

Certiorari Granted

The government petitioned the Supreme Court to review the case in June. The government emphasized that with thousands of refund claims and cases worth a combined total of more than $1 billion currently in the lower courts, the importance of the issue and the Circuit conflict clearly call for the Supreme Court's review. The Supreme Court granted certiorari on October 1, 2013. Its eventual decision is expected to resolve the circuit split.

If you have questions about severance pay or the application of FICA tax or other employment taxes, please contact Dina Ouellette at

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