This post was contributed by Tony D. Dick, an Attorney in McNees Wallace & Nurick's Labor & Employment Practice Group in Columbus, Ohio.
On Tuesday, the U.S. Supreme Court ruled unanimously (Justice Kagan recused herself) in United States v. Quality Stores, Inc., Case No. 12-1408 that severance payments made to employees who were involuntarily terminated are taxable wages under the Federal Insurance Contributions Act (FICA). The decision overturns a previous ruling from the Sixth Circuit Court of Appeals in favor of Quality Stores which was seeking a $1 million tax refund from the IRS based on its claim that severance payments were not covered by FICA.
At issue was the definition of “wages” under FICA. Under federal tax law, “wages” are defined as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” Quality Stores contended that its severance payments to its terminated employees fell outside the definition of “wages” and constituted supplemental unemployment compensation benefits (SUBs) which are not considered taxable under the Internal Revenue Code.
In support of this contention, Quality Stores pointed to 26 U.S.C. § 3402(o) – a statute which deals with income tax withholdings – which provides that SUBs “paid to an individual . . . shall be treated as if it were a payment of wages by an employer to an employee….” According to Quality Stores, this language established that SUBs were not actually wages, but were only to be treated "as if" they were wages for income tax withholding purposes and since FICA uses a substantially similar definition, SUBs should not be found to be wages for FICA tax purposes.
The Supreme Court ultimately disagreed with Quality Stores’ position. In the unanimous opinion written by Justice Kennedy, the Court held that FICA defines wages broadly as “all remuneration for employment,” and includes “not only work actually done but the entire employer-employee relationship for which compensation is paid.” This would include the severance payments at issue. In further support of its holding, the Court also referenced the legislative history of FICA and cited to 26 U.S.C. 3121(a)(13)(A) which exempts from “wages” severance payments provided “because of . . . retirement for disability.” The Court reasoned that the fact that FICA contained this and other exemptions was further support for the proposition that severance payments are wages. Otherwise, the exemption would be superfluous.
After the Sixth Circuit’s ruling in this case, many employers filed refund claims for FICA taxes previously paid on severance payments. Those claims are now moot. Any employer who stopped withholding FICA taxes on severance payments in reliance on the Sixth Circuit’s earlier ruling will likely need to amend previous returns to pay the outstanding FICA taxes.