On March 25, 2014, the U.S. Supreme Court ruled that severance payments made to workers who were terminated as part of a Chapter 11 bankruptcy were “wages” subject to Federal Insurance Contributions Act (FICA) taxes (United States v. Quality Stores).
This ruling likely will not be news to most employers that have been paying FICA on severance payments for years. However, the issue was thrown into doubt by various rulings in connection with the Quality Stores bankruptcy. The lawyers involved in that case hit on a theory, based on a close reading of the statutory language, that severance payments are not “wages” for purposes of FICA. They then sought a refund of FICA taxes that had been paid in connection with various layoffs.
Somewhat surprisingly, the bankruptcy court, the district court, and the 6th Circuit all agreed with Quality Stores’ arguments. Though a legally narrow issue, it is one with substantial revenue implications. If the lower court decisions had stood, the IRS would have been flooded with refund filings (to the tune of $1 billion according to court documents). However, the Supreme Court shot the theory down 8-0.
For most employers, this decision won’t change anything about the way they handle severance payments and FICA. For those that were hoping they could piggyback off of Quality Stores and seek their own FICA refunds, that hope is now over.