As corporate downsizing becomes more commonplace in today’s challenging business environment, severance payments to departing workers are under more scrutiny. It is well established that such severance payments are included in workers’ gross income and subject to federal income tax withholding. But whether such severance payments are wages for purposes of the Federal Insurance Contributions Act has become a controversial issue over the years. Much of the debate stems from the intertwined and complex history of the federal income tax withholding and the FICA tax provisions.
Last year, the issue came to a head when the U.S. Court of Appeals for the Sixth Circuit, in United States v. Quality Stores, 110 AFTR 2d 2012-5827 (6th Cir. 2012), upheld the bankruptcy court’s decision that payments made to employees upon terminating their employment due to business cessation constituted supplemental unemployment compensation benefits (SUB payments) and were not taxable as wages for purposes of FICA tax. This holding caused a split in the circuits because the U.S. Court of Appeals for the Federal Circuit in 2008 reversed a similar holding in CSX v. United States, 101 AFTR 2d 2008-1120 (CA Fed Cir. 2008). As a result of the Sixth Circuit’s decision, employers nationwide, but specifically those employers from the Sixth Circuit, filed refund claims for FICA taxes paid on severance payments in recent years. More importantly, the U.S. Supreme Court on Oct. 1 agreed to review the Sixth Circuit’s decision to resolve the circuit split. Pending the Supreme Court’s decision, the Internal Revenue Service has suspended all action on refund claims submitted by employers from the Sixth Circuit, which are estimated to be approximately $127 million.
