Supreme Court: Fired? Your severance payments are taxable under FICA

April 3, 2014

Supreme Court BuildingThe U.S. Supreme Court says the 6th Circuit relied on the wrong statute in concluding that severance payments made to employees terminated against their will are not taxable wages under the Federal Insurance Contributions Act.

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Justice Anthony Kennedy said the 6th Circuit erred in relying not on FICA’s definition of “wages” but on Section 3402(o) of the Internal Revenue Code — a provision governing income-tax withholding.  Section 3402(o) instructs that any severance payment “shall be treated as if it were a payment of wages.”

Chapter 11 debtor Quality Stores, as well as the lower courts, hung their hats on the “treated as if” language to argue that severance payments are not wages.

But Justice Kennedy said FICA’s broad definition of wages included the severance payments, and Section 3402(o) did not alter the definition.

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The case involved Quality Stores’ suit against the IRS in Michigan bankruptcy court.

QS sought, on its own behalf and on behalf of its former employees, a $1 million dollar refund.  The company had reported its former employees’ severance payments as wages, paid the employer’s share of FICA taxes, and withheld employees’ share of FICA taxes.

But Quality Stores believed all along the severance payments were not wages.

When the matter hit the courts, the Bankruptcy Court, the District Court and the 6th Circuit agreed.

Not so the Supreme Court.

Justice Kennedy said FICA exempted from taxable wages any severance payments made “because of … retirement for disability.”  That exemption would be unnecessary were severance payments in general not within FICA’s definition of “wages.”

The justice also rejected QS’s argument that Section 3402(o) limited the meaning of “wages” for FICA purposes.  Analysis of the statutory language went against the debtor as did the underlying regulatory background.

United States v. Quality Stores Inc. et al., No. 12-1408, 2014 WL 1168968 (U.S. Mar. 25, 2014) Opinion