US v. Quality Stores, Inc.: Supreme Courts Finds Severance Payments Taxable Wages Under FICA

In an 8-0 decision[1] issued March 25, 2014 in United States v. Quality Stores, Inc., the Supreme Court held that severance payments made to employees who are involuntarily terminated are taxable wages for the purposes of withholding Federal Insurance Contributions Act (“FICA”) taxes, i.e., Social Security and Medicare. This decision resolves a circuit split created when the Sixth Circuit ruled in 2012 that these kinds of severance payments did not constitute “wages” under FICA[2] while the Third, Eighth and Federal Circuits had all previously held that at least some severance payments were “wages” subject to FICA taxes.[3]

In the wake of this decision, employers should, under most circumstances, treat severance payments made to involuntarily terminated employees as taxable wages subject to FICA taxes. There are exceptions to the general rule, however, and it is important for employers to seek competent legal counsel to assist in determining the tax status of a specific severance program.

Background

Quality Stores, Inc. filed an involuntary Chapter 11 bankruptcy petition in 2001 and, along with its affiliated companies (collectively “Quality Stores”), terminated thousands of employees in connection with the bankruptcy. The terminated employees received severance pay ranging from one-week to 18-months depending on years of service and position. The severance pay was not tied to receipt of state unemployment benefits. Quality Stores reported the payments as wages on the employees’ W-2 tax forms, paid the employer’s share of FICA taxes, and withheld the employees’ share of FICA taxes. Quality Stores subsequently filed for a refund of the FICA taxes on its own behalf and for certain employees who had authorized it to file on their behalf. When the Internal Revenue Service (“IRS”) took no action on the refund claim, Quality Stores initiated a proceeding in Bankruptcy Court. The Bankruptcy Court granted summary judgment in favor of Quality Stores and the District Court and Sixth Circuit Court of Appeals subsequently affirmed.

Quality Stores argued that severance payments did not qualify as “wages” under FICA, notwithstanding the broad definition of “wages” in the statute. The company asserted that because such payments were merely deemed to be wages for income tax withholding purposes under Section 3402(o) of the Internal Revenue Code,[4] they did not actually qualify as “wages” as defined in the code. Accordingly, the company argued that...