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Some Men Are Six Feet Tall, Some Severance Payments Are Taxable

On March 25, 2014, the Supreme Court ruled that severance payments to laid-off workers are subject to Social Security and Medicare taxes under the Federal Insurance Contributions Act, or FICA. The decision, which has implications for both employers and employees, resolved a split among the federal circuit courts over the taxability of such severance payments.

The Issue.

The issue before the Supreme Court was whether severance payments to laid-off workers qualify as “wages” under FICA. FICA defines “wages” broadly as “all remuneration for employment.”   “Employment” is defined as “any service … performed … by an employee” for an employer.

The case arose from the 2001 bankruptcy of Quality Stores Inc., once the country’s largest agricultural specialty retailer. Quality Stores made severance payments to some 1850 employees that it laid-off when the company filed for bankruptcy. Quality Stores initially withheld FICA taxes from the severance payments, but later concluded that those payments should not have been taxed as wages. It sought a refund from the IRS, which the agency neither allowed nor denied. That prompted Quality Stores to initiate a proceeding in the Bankruptcy Court seeking a refund of the FICA taxes. The Bankruptcy Court granted summary judgment in favor of Quality Stores and the District Court and Sixth Circuit affirmed, concluding that the severance payments did not qualify as “wages” under FICA.

The Supreme Court granted certiorari to resolve a split between the Sixth Circuit and [other circuits] over the issue. Ultimately, the Supreme Court reversed, concluding that the severance payments qualified as “wages” under FICA.

The Decision.

The Court reasoned, first, that FICA’s plain language required the Quality Stores’ severance payments to be treated as “wages.” Quality Stores made the payments only to employees and it did so in consideration for services they performed. Thus, the Court held, the payments plainly constituted “remuneration for employment” within the meaning of FICA.

The Court found that the severance plan documents bolstered this conclusion. Severance payments, the Court noted, often vary according to the duties and seniority of the terminated employee. In typical fashion, Quality Stores’ severance plan based payments on factors like an employee’s job grade, management level, and years of service to the company. Thus, the Court found, the Quality Stores’ severance plans reflected a company policy to reward employees for their performance and loyalty to the company. Therefore, payments made pursuant to the plan constituted consideration for services rendered.

Further reinforcing the Court’s decision were FICA exemptions which applied to certain types of termination-related payments, such as payments to employees who retire due to disability. The Court concluded that this disability exemption “would not be necessary were severance payments in general not within FICA’s definition of ‘wages.’”

Finally, the Court rejected Quality Stores’ argument that the Internal Revenue Code chapter governing income tax withholding limits FICA’s definition of “wages.” Like FICA, the IRC broadly defines “wages” and provides specific exemptions. Section 3402(0) instructs that “supplemental unemployment compensation benefits,” which include severance payments, should be treated “as if” they were wages.   Quality Stores argued that this “as if” language meant that severance payments, by definition, are not “wages” under the IRC, nor should they be under FICA.   The Supreme Court disagreed, commenting that “the statement that all men shall be treated as if they were six feet tall does not imply that no men are six feet tall.”   Thus, the Court held, the “as if” language “is in all respects consistent with the proposition that at least some severance payments are wages.”


The Supreme Court’s decision will have immediate, drastic implications for thousands of employers and employees. At the time of the decision, there were reportedly eleven unresolved lawsuits and 2400 administrative cases involving refund requests similar to Quality Stores. At stake was over $1 billion dollars in taxpayer refunds. While arguably leaving open the debate for some types of severance payments, the Quality Stores opinion largely puts to rest liability for those refunds. The unanimous ruling marks a victory for the IRS but a blow to employers and employees and other organizations fighting for refunds.   It may also open the door to proceedings by the IRS to collect payments from employers who previously failed to pay FICA on certain types of severance payments.

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