Overview: Severance pay paid to employees who are terminated from employment is subject to payroll withholding for federal income tax (FIT), Social Security and Medicare (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 supplemental unemployment benefits (SUB).
Trends: As a result of a recent decision by the Sixth Circuit Court of Appeals, employers that have paid severance pay to terminated employees have been questioning whether they should file FICA tax refund claims with the Internal Revenue Service (IRS) and stop withholding and paying FICA taxes on severance pay. To avoid potential penalties, however, employers should continue to withhold FICA taxes from severance paid to terminated employees until this issue is resolved.
In United States v. Quality Stores, Inc., (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 SUB payments, which were not FICA or FUTA taxable. The court rejected an earlier Federal Circuit Court ruling (CSX Corp, Inc., v. U.S., (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.
On October 18, 2012, the US Department of Justice (DOJ) filed a petition for a rehearing of the case by all of the active Sixth Circuit judges. If a rehearing is denied, or the judges issue an opinion in favor of Quality Stores, the DOJ may still ask the US Supreme Court to review the case, which will further prolong a final resolution.
Author: Rena Pirsos, JD, Legal Editor
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Employees' salary and fringe benefits are subject to federal income taxes, Social Security and Medicare taxes, and federal unemployment insurance tax. However, certain cash and noncash fringe benefits may be offered to employees on a tax-free basis, while an otherwise tax-free fringe benefit becomes taxable compensation to employees if employers do not meet the rules for that particular fringe benefit .This section assists HR professionals in determining which fringe benefits (e.g., company car, health benefits) and other compensation (e.g., bonuses, awards) are taxable or not.
An employer may use this policy to convey the purpose for and importance of conducting exit interviews with employees departing the organization. Given that employers may collect valuable, candid information regarding employment practices from outgoing employees and may also identify post-termination risks such as lawsuits, employers are strongly encouraged to conduct exit interviews with all willing, outgoing employees. This policy can be used to put current employees on notice of the employer's intention to conduct such interviews and what the employer intends to do with the information it gathers.
The appellate court affirmed the decisions of a federal district court and a bankruptcy court that payments to terminated employees were supplemental unemployment payments, which were not FICA or FUTA taxable.
In CSX Corp, Inc., v. U.S., the Federal Circuit Court of Appeals ruled that supplemental unemployment benefits (SUB) are subject to FICA taxes. In U.S. v. Quality Stores Inc., the 6th Circuit Court of Appeals came to the opposite conclusion - that the income tax and FICA tax statutes must be read in parallel.
In-depth review of the spectrum of California employment law requirements HR must follow with respect to process of termination.
Over the past several years, an increasing number of employers have decided to include payroll operations within the HR department rather than within the finance or accounting department. This section assists HR professionals in understanding all the issues involved in payroll tax law compliance in order to effectively oversee and manage payroll operations.
HR guidance regarding the taxation of severance pay.
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