US Supreme Court says payments under severance agreements subject to FICA withholding

The US Supreme Court issued an important decision on March 25, 2014, US v. Quality Stores, Inc., et al. (No. 12-1408). Quality Stores, Inc., closed down and made severance payments to 3100 of its former employees.  The amount of the payments was keyed to position and time in service. Originally, Quality Stores treated the payments as “wages”, and withheld social security taxes (and made the employer’s matching contribution).  In the bankruptcy setting, however, Quality Stores concluded that the severance payments should not have been treated as “wages”, and asked for refunds of the withheld SS taxes on behalf of itself and the employees. The IRS considered the claim, but had not acted; so Quality Stores petitioned the bankruptcy court for an order on the subject, and the bankruptcy court held that the severance payments were not “wages” and that the withheld amounts should be refunded. The Six Circuit Court of Appeals upheld that Order.  The US Supreme Court, though, reversed the decision, and has held that the severance payments were properly treated as “wages” and that the withholding was required (so, no refund).  The Supreme Court cited the broad definition of “wages” in the Federal Insurance Contributions Act (26 USC 3101 et seq).  The applicable provisions very broadly define “wages” for FICA purposes, and afford only narrow exceptions that no longer include severance payments (the court observed that, at one time, severance payments were specifically exempted from FICA taxes).  Employers and employees (and their lawyers, including me) will carefully scrutinize the decision to judge how its impact can be limited or distinguished; but, initially, it looks like employers will be forced to treat severance pay as wages and withhold Social Security taxes (and make the employer’s matching contribution).  The immediate impact of that is to marginally reduce the value of the severance payments to the former employees while increasing their cost to the employer (while benefiting the SS trust fund).  Will it be practical to specify portions of severance agreements not to be treated as wages?  Will the obligation to withhold be extended to other items, such as income taxes?  Will the decision affect payments pursuant to settlement agreements?  I’ll post again after I’ve examined the decision more closely.

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