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).
Trends: 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 overturns 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.
The IRS has issued guidance explaining how it will apply the Supreme Court's decision in United States v. Quality Stores, Inc. to claims for refund of employment taxes paid on severance payments.
XpertHR has added new content on creating severance or termination agreements with outgoing employees. These agreements can be tremendously helpful in protecting employers from risk following employee terminations.
The new and updated content follows the US Supreme Court ruling in United States v. Quality Stores, Inc., that FICA taxes apply to most severance pay plans.
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.
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.
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HR guidance regarding the taxation of severance pay.