Severance Payments Subject to FICA Taxes


The US Supreme Court recently reversed the Sixth Circuit Court of Appeals and held that severance payments made to involuntarily terminated employees were subject to payroll tax. The Court concluded that the severance payments at issue fell within the broad definition of “wages” used for FICA tax purposes and rejected the taxpayer’s argument that the treatment of such payments was altered by a special income tax withholding provision.

The taxpayer in this case was Quality Stores who was seeking a refund of approximately $1 million.  According to the government’s petition, the total dollar amount at stake including other pending refund claims and litigation was over $1 billion.

In general, “wages” are defined for FICA tax purposes as all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. The US Supreme Court had previously held in a case decided in 1981 that Congress intended a uniform definition of “wages” for purposes of FICA, FUTA, and income tax withholding.  But Congress disagreed and subsequently amended the Internal Revenue Code to add a so-called “de-coupling” rule.  Under this de-coupling rule, nothing in the income tax withholding regulations which provided an exclusion from wages for withholding purposes was to be construed to require a similar exclusion from wages for FICA purposes.

Quality had made severance payments to terminated employees and treated these payments initially as wages for FICA and withholding purposes.  But, Quality subsequently filed refund claims with IRS for overpaid FICA, plus interest, on the severance payments. When IRS did not allow the refund claims, Quality filed an adversary action in the bankruptcy court, and that court concluded that the severance payments were not wages for FICA purposes. The district court and the Sixth Circuit affirmed.  However, other Courts of Appeal had previously held to the contrary.

The IRS appealed to the US Supreme Court and won.  The Supreme Court, held that (i) the severance payments in question were within FICA’s definition of wages, and (ii) the income tax withholding provisions did not change that classification.

In its decision, the Court did note that the most recent IRS Revenue Ruling still provides that severance payments tied to the receipt of State unemployment benefits are exempt from both income-tax withholding and FICA taxation.  But since the severance payments in the Quality case were not tied to State unemployment benefits, the Court did not address whether the IRS’s exemption of such severance payments (taxpayer friendly) was consistent with FICA’s broad definition of wages.

If you have questions about whether any type of compensation, severance, unemployment or other settlement payment are subject to federal or state income or payroll taxes, please call or email me at or 937-223-1130.

AND ONE MORE THING.  The Internal Revenue Service estimates that over 900,000 taxpayers who would be entitled to a tax refund check for 2010 have not filed their federal income tax returns for 2010.  The IRS estimates that these tax refunds would be in excess of $760 million, with more than half of the potential refunds being in excess of $571.  In order to collect these refunds, taxpayers must file their 2010 income tax returns on or before Tuesday, April 15, 2014.  If you know someone who hasn’t filed a 2010 federal income tax return, give them a heads up and refer them to a CPA or other competent tax return preparer.  If you need a referral, give me a call or email at or 937-223-1130.

AUTHOR: Jeff Senney