In a unanimous 8-0 decision issued on March 25, 2014, the United States Supreme Court held that severance payments made to employees terminated against their will are taxable wages under the Federal Insurance Contributions Act (FICA), 26 U.S.C. § 3101 et seq. See United States v. Quality Stores, Inc., 572 U.S. ___ (2014), available here. The decision reversed the holding of the United States Court of Appeals for the Sixth Circuit and courts below that the payments were not taxable wages under FICA. The decision also resolved the circuit split that the Sixth Circuit’s ruling created with the Federal Circuit’s ruling in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

In its decision, the Supreme Court noted that the Internal Revenue Code defines “wages” broadly for FICA purposes and includes “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” It pointed out that “common sense dictates that employees receive [severance] payments ‘for employment’” and that “as a matter of plain meaning, severance payments made to terminated employees are ‘remuneration for employment.’”

The Court also examined the definition of wages for income tax withholding purposes and determined that this definition is similarly broad and does not narrow the definition of wages under FICA to exempt all severance payments. The Court noted that to hold otherwise, would disregard the Court’s holding in Rowan Cos. v. United States, 452 U.S. 247 (1981), that “there should be congruence in the rules for FICA and income-tax withholding.”

IRS revenue rulings holding that severance payments tied to the receipt of state unemployment benefits are exempt from both income tax withholding and FICA tax were not substantively addressed by the Court because the severance payments at issue in Quality Stores were not tied to state unemployment benefits.

Before the Supreme Court’s decision in Quality Stores, there was, according to the government’s petition in the case, more than $1 billion at stake, with eleven cases and over 2,400 claims for refund of FICA withholding taxes pending with the IRS. The IRS had suspended most refund claims while the government was deciding whether to seek the Supreme Court’s review in the case.

As a result of this decision, employers must continue to withhold FICA tax on severance payments that are made to employees terminated against their will and not linked to state unemployment benefits. Employers no longer need to file protective claims for refund of FICA tax withheld on such payments. For employers that did file protective claims, they can expect the IRS to deny their claims.

The IRS has been focused on employment tax and related issues in recent years and that climate is not expected to change in the near future. Employers should be aware that attempts to convert promised severance payments into non-wage payments (e.g., consulting fees) in order to avoid FICA tax can subject both the employer and employee to IRS scrutiny and possible penalties.