During the past few years, more and more employers have found themselves in the unenviable position of having to lay off workers due to the economy. Of course, the sting is felt more acutely by the laid off worker. In order to lessen the sting and retain goodwill, employers sometimes grant the separated employee severance. While most employers know that severance payments are wages for income tax purposes and, thus, income tax must be withheld on behalf of the employee, withholding pursuant to the Federal Insurance Contributions Act (FICA) has not been as clear.
For the uninitiated, FICA taxes pay for Social Security and Medicare. The employer and the employee both pay a portion of the tax, with the employee’s portion withheld and sent to the IRS by the employer. As with other trust fund taxes, certain officers of the employer can find themselves personally liable if the employee’s portion (which is held in trust) is not paid to the government.
The issue of whether an employer must withhold FICA taxes from severance payments came before the Supreme Court in United States v. Quality Stores, Inc., No. 12-1408, 572 U.S. ____ (2014), decided on March 25, 2014. Quality Stores was an agricultural-specialty retailer that went into an involuntary Chapter 11 bankruptcy in 2001. Both before and after entering bankruptcy, Quality Stores made severance payments to employees pursuant to two different severance plans. The severance payments were based on, among other things, job seniority and time served, and were not tied to the receipt of unemployment benefits. Quality Stores withheld and paid FICA taxes, and subsequently filed for a refund. The Federal Bankruptcy Court, Federal District Court and Court of Appeals for the Sixth Circuit all sided with Quality Stores, ruling that severance payments were not wages under FICA.
The Supreme Court disagreed. In a seemingly straightforward analysis, the Court looked to the broad definition of “wages” under FICA and concluded that severance payments were “remuneration for employment.” It noted that the severance payments were only made to employees and were based on employees’ service to the employer. The Court also rejected a technical argument that the income-tax withholding statute designated severance payments as something other than wages. The Court noted that the legislative history of the income-tax provision, as well as previous Supreme Court caselaw, mitigate against the proposed interpretation.
This ruling ends a split among the circuits and makes clear what many employers already know: When making a severance payment, fully withhold employment taxes.