New Sixth Circuit Ruling Leaves FICA Taxation of Severance Pay Unsettled

Author: Rena Pirsos, XpertHR Legal Editor

US employers that have paid severance pay to terminated employees are now likely to be questioning whether they should file FICA (Social Security and Medicare) tax refund claims with the Internal Revenue Service (IRS) and stop withholding and paying FICA taxes on severance pay as a result of a recent decision by the Sixth Circuit Court of Appeals.

However, employers should proceed with caution as the IRS has not yet indicated whether it will ask the Supreme Court to review the decision or request the Sixth Circuit to rehear the case.

In United States v. Quality Stores, Inc., (+2012 U.S. App. LEXIS 18820 (6th Cir. Sept. 7, 2012)), the appellate court affirmed the decision of both a federal district court and a bankruptcy court that payments to terminated employees because of a business's dissolution were supplemental unemployment (SUB) payments, which were not FICA or FUTA (Federal Unemployment Tax Act) taxable.

The court rejected an earlier Federal Circuit Court ruling (CSX Corp, Inc., v. U.S., +518 F. 3d 1328 (Fed. Cir. 2008)) which held that severance payments were subject to FICA taxes because they did not fit the IRS's administrative definition of SUB pay.

The Quality Stores decision applies only to employers that are located in the Sixth Circuit - Kentucky, Michigan, Ohio, and Tennessee. Unless the severance pay meets the IRS's definition of SUB pay, employers in other states, and possibly employers located within the Sixth Circuit's jurisdiction, should continue to withhold FICA taxes from severance paid to terminated employees.

XpertHR has updated its ELM content to incorporate this decision and has also added a law report which contains a more in-depth explanation of the ruling and what it may mean for employers.

Additional Resources

FICA Taxation of Severance Pay Remains Unsettled

Payroll > Taxation of Employee Compensation > Supplemental Unemployment Benefits

Payroll > Taxation of Employee Compensation > Severance Pay