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, the Internal Revenue Service (IRS) treats severance pay 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 (SUBs).
The US Supreme Court unanimously ruled in United States v. Quality Stores, Inc., No. 12-1408 (U.S. Sup. Ct., 3-25-14), that severance payments made to involuntarily terminated employees that do not qualify as SUBs under the Internal Revenue Code are subject to Social Security and Medicare (FICA) taxes. The decision overturned a lower court ruling that could have required the IRS to issue more than $1 billion in refunds.
Author: Rena Pirsos, JD, Legal Editor
This How To maps out the steps an employer should follow in order to properly pay an employee who has separated, or has been involuntary terminated, from employment.
California employers seeking to provide an overview of separation from employment, including classifications of the types of separation and recommended procedures, should consider including this model policy statement in their handbook.
In U.S. v. Quality Stores Inc., the US Supreme Court reversed a decision of the 6th Circuit Court of Appeals and ruled that severance pay that was not tied to the receipt of state unemployment benefits was subject to FICA taxes.
In-depth review of the spectrum of Alabama employment law requirements HR must follow in respect to taxation of employee compensation.
In-depth review of the spectrum of California employment law requirements HR must follow with respect to process of termination.
HR guidance regarding the taxation of severance pay.