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Supreme Court to Weigh Taxability of Severance Payments

The U.S. Supreme Court will decide in the upcoming term whether the I.R.S. can tax severance payments to laid-off workers.

The Supreme Court case arises from the 2001 bankruptcy of a Midwestern retailer named Quality Stores. The retailer laid off thousands of workers to whom it made severance payments. Quality Stores withheld FICA (i.e., Medicare and Social Security) taxes from these severance payments. Federal law requires employers and employees to pay FICA taxes on “employee wages.”

Quality Stores and certain of its former employees later petitioned the bankruptcy court for a refund of more than $1 million dollars in FICA taxes. They argued that the severance payments did not constitute taxable employee wages under FICA. The bankruptcy court agreed, ordering a full refund of the FICA withholdings. In September 2012, the Sixth Circuit Court of Appeals affirmed the bankruptcy court’s decision. (A copy of the Sixth Circuit’s opinion is available here.) The I.R.S. appealed the Sixth Circuit’s decision to the U.S. Supreme Court, which agreed to hear the case.

The case has substantial implications for laid-off workers, their former employers, and the government. If Quality Stores prevails, the government claims there are more than 2,400 refund claims pending on the same issue. Given the vast number of layoffs that occurred during the Great Recession, that figure could easily increase.

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