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Supreme Court Holds Severance Payments Are Taxable

by Katherine Tracy

The United States Supreme Court issued an important ruling on March 25, 2014 holding severance payments are taxable wages for FICA purposes. United States v. Quality Stores, Inc., No. 12–1408, 2014 WL 1168968. As background, to fund benefits provided by the Social Security Act and Medicare, FICA taxes “wages” that an employer pays or that an employee receives “with respect to employment.” The March 25th ruling made clear that severance payments made to departing employees are taxable under FICA.

FICA broadly defines “wages” to include “all remuneration for employment”. 26 U.S.C. § 3121(a). Additionally, the Court held that severance payments fall squarely within the broad textual definition of wages for purposes of income-tax withholding under § 3401(a) of the Internal Revenue Code.

The Court was careful to point out that the IRS still provides that severance payments tied to the receipt of state unemployment benefits are exempt not only from income-tax withholding but also from FICA taxation. The ruling on March 25th did not change the tax treatment of state unemployment benefits. However, the Court left the door open as to whether state unemployment benefits should be taxed for purposes of income-tax withholding and FICA.

The case had significant damages in play. Quality Stores sought a refund of over $1 million in FICA taxes. The sum is staggering but it could have triggered additional employers and employees across the country to file for similar refunds in FICA taxes.

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