Supreme Court to Resolve Whether Severance Pay Is Subject to FICA
Author: Rena Pirsos, XpertHR Legal Editor
UPDATE: On January 14, 2014, the US Supreme Court heard oral arguments in US v. Quality Stores, discussed below. Pending the Court's final decision, an employer that may have paid out severance in 2010 should consider filing a protective refund claim for 2010 by April 15, 2014 to secure its right to a potential refund in case the Court decides in favor of Quality Stores. An employer that filed a protective refund claim for years prior to 2010, and later received a Notice of Claim Disallowance, should consider filing Form 907, Agreement to Extend Time to Bring Suit.
October 3, 2013
The US Supreme Court has agreed to hear the appeal of a Sixth Circuit Court of Appeals ruling that severance payments to employees who involuntarily lost their jobs are supplemental unemployment benefits (SUB), which are not subject to Social Security and Medicare (FICA) taxes. U.S. v Quality Stores, Inc., No 12-1408 (U.S. Sup. Ct., 10-1-13). Because severance payments are currently treated as FICA taxable wages, a ruling by the Court that severance pay is not taxable would result in millions in savings for the employer community.
Specifically, an employer would no longer be required to make FICA contributions on severance payments, and it may be able to obtain refunds of FICA on severance already paid. To be safe, employers should consider filing protective refund claims now to keep the statute of limitations open while the Court reviews the case. An employer may also choose to inform former employees who were paid severance that they too may file protective refund claims of FICA taxes withheld from their severance payments.
The Internal Revenue Service (IRS) currently treats severance pay as subject to employer withholding for federal income tax, FICA tax and federal unemployment insurance (FUTA) tax. For income tax withholding purposes, severance pay is treated as supplemental wages, i.e., wages paid in addition to employees' regular wages. As part of a severance pay package, employers may also provide SUB.
As a result of the Sixth Circuit's decision, employers that have paid severance to terminated employees questioned whether they should file FICA tax refund claims with the IRS and stop withholding and paying FICA taxes on severance payments. To avoid potential penalties, however, employers were advised to continue to withhold FICA taxes until resolution of the issue.
The Sixth Circuit 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 SUB payments, which were not FICA or FUTA taxable. In doing so it rejected an earlier Federal Circuit Court ruling in CSX Corp, Inc., v. U.S., which held the opposite - severance payments are subject to FICA taxes because they do not fit the IRS's administrative definition of SUB pay. This caused a circuit split.
On October 18, 2012, the US Department of Justice (DOJ) filed a petition for a rehearing of the case before all of the active Sixth Circuit judges. The Sixth Circuit denied the petition on January 4, 2013. However, the DOJ filed a petition with the Supreme Court, which has now agreed to resolve the issue.
Briefings and oral arguments in the case will occur in the next several months and a decision by the Court is expected in its current term, which ends in June 2014.