Supreme Court Finds Severance Payments Subject to FICA in Quality Stores

Writing for an 8-0 majority, with Justice Kagan abstaining, Justice Anthony Kennedy handed down the Supreme Court’s ruling in the closely-watched United States v. Quality Stores, Inc., et al. case March 25, holding that severance payments to involuntarily terminated employees are taxable wages under the Federal Insurance Contributions Act (FICA), and thus subject to Social Security and Medicare withholding.  The Court took issue with a Sixth Circuit opinion which had found such payments not subject to withholding, stating that “[t]o reach its holding, the [Sixth Circuit] Court of Appeals relied not on FICA’s definition of wages but on §3402(o) of the Internal Revenue Code, a provision governing income-tax withholding. That conclusion, for the reasons to be discussed, was incorrect. FICA’s broad definition of wages includes the severance payments made here. And §3402(o) does not alter that definition.”

Quality Stores Inc., once the country’s largest agricultural specialty retailer, had claimed a $1 million refund of withholding paid for 3100 employees laid off during the Great Recession, arguing that the payments were “supplemental unemployment compensation”, which Section 3402 arguably distinguished from wages by providing that they are to be treated “as if” they are wages. However, Justice Kennedy’s opinion notes that “this ‘as if’ instruction does not mean that severance payments fall outside the definition of ‘wages’ for income tax withholding purposes and, in turn, are not covered by FICA’s definition.”  After discussing the regulatory background behind Section 3402, Justice Kennedy concluded “the assumption that Congress meant to include all [supplemental unemployment benefits] from the definition of ‘wages’ is unsustainable.”

Taxpayer Impact:

The IRS had expressed concern over the ramifications of the Court’s ruling in its filings.  Some estimates of the amount of potential refund claims that could have ensued had the Court ruled that the payments were not subject to FICA reached as much as $1 billion. The Court’s ruling in Quality Stores puts an end to this concern and provides a clear requirement for employers to withhold FICA from severance payments.

About the Author

George E. Morrison
George advises corporate clients on formation, succession, and transactional issues as well as general business matters. He is involved in all areas of corporate practice, including mergers and acquisitions, liquidations, reorganizations and corporate governance. George has extensive experience advising borrowers and lenders in commercial lending transactions and in the preparation of third-party closing opinions.