Supreme Court to Decide if Severance Pay is Subject to FICA Tax

By James A. Nitsche

The Supreme Court has announced that it will review a decision of the Sixth Circuit Court of Appeals that payments made by a company to employees pursuant to a severance plan were not “wages” subject to Federal Insurance Contribution Act (“FICA”) taxes.

In the Sixth Circuit case, In Re Quality Stores, Inc., 693 F2d 605 (6^th Cir. 2012), an employer made severance payments to employees whose employment was terminated involuntarily when the employer closed its stores and discontinued business.  The employer withheld income and FICA taxes from payments made to the terminated employees, and paid the employer’s share of FICA taxes with respect to such payments, but subsequently filed claims requesting refunds of all such FICA taxes.  When the IRS denied the refund claims, the employer filed a suit for refund as part of a bankruptcy proceeding.  The bankruptcy court ordered a full refund, holding that the payments made by the employer to its terminated employees constituted supplemental unemployment compensation benefits that are not treated as wages for FICA tax purposes.  The Sixth Circuit affirmed the bankruptcy court’s decision.

The Quality Stores decision hinged on the courts’ analysis of the relationship between the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), that require withholding of income and FICA taxes on “wages” paid to employees.  In general, Code Section 3402(a) requires an employer to withhold income taxes on “wages,” as defined by Code Section 3401(a), paid to employees.  Meanwhile, Code Section 3102(a) requires that FICA taxes be withheld from “wages,” as defined by Code Section 3121(a), paid to employees.  While the definition of wages under Code Section 3401(a) may be substantially similar to the definition of wages under Code Section 3121(a), the two are not identical.  Nevertheless, in Rowan Cos. v. United States, 452 U.S. 247 (1981), the Supreme Court examined the language and legislative history of Code Sections 3401(a) and 3121(a) to conclude that Congress intended the term “ wages” to carry the same meaning for purposes of income tax and FICA tax withholding.