Employment-Sixth Circuit Rules That Severance Payments Made To Employees Involuntarily Terminated When The Employer Closed Its Business Are SUB Payments, Which Are Not Subject To FICA Tax

In United States of America v. Quality Stores, Inc., No. 10-1563 (6th Cir. 2012), the Sixth Circuit Court of Appeals (the “Court”) faced an appeal by the U.S. of a district court decision granting Quality Stores, Inc. (“Quality Stores”) a refund of $1,000,125 in taxes paid under the Federal Insurance Contributions Act (“FICA”) on severance payments made to terminated employees.

In this case, Quality Stores and had closed its corporate office, stores and distribution centers, and had terminated, involuntarily, all of its employees. Quality Stores made severance payments to the terminated employees. The U.S. and Quality Stores agree that these severance payments resulted directly from a reduction in force or the discontinuance of a plant or operation. The severance payments were made under two plans: (1) the Pre-(Bankruptcy) Petition Severance Plan, under which the amount of the payment was based on job grade and management level in the organization, and (2) the Post-Petition Severance Plan, under which the amount of the payment was based on position in the organization, and was received if the employee completed his or her last day of scheduled service. Under both plans, the receipt of severance pay was not tied to the receipt of state unemployment compensation or the provision of any particular services. Quality Stores treated the severance payments as being included in employees’ gross income. It paid and withheld FICA taxes on the severance payments, but subsequently sought a refund on those taxes. The issue for the Court: are the severance payments-which constitute supplemental unemployment benefit (“SUB”) payments- “wages” and thus subject to FICA tax?

In analyzing the case, the Court noted that the SUB payments in this case will be subject to the FICA tax if they are “wages”. However, the FICA statute (which is part of the Internal Revenue Code or the “Code”)) does not expressly include or exclude SUB payments in or from being “wages” for FICA purposes. The applicable Treasury regulations do not address the subject. For purposes of federal income tax withholding, a SUB payment is treated “as if it were a payment of wages” (Code section 3402(o)(1)). This indicates that Congress did not think that SUB payments are actually wages. Also, the SUB payments in this case fit the definition of SUB payments for tax withholding purposes (see Code section 3402(o)(2)(A)) -and therefore, again, are not the type of payment that Congress thinks are wages. Based on this, the Court concluded that the SUB payments in this case should not be treated as “wages” for FICA purposes. Accordingly, the Court upheld the district court’s ruling and Quality Stores’ entitlement to the refund of the FICA taxes.

Note: This Sixth Circuit decision appears to be at odds with a decision from the Federal Circuit, CSX Corp. v. United States, which indicates that SUB payments are subject to FICA tax. This FICA tax issue is a candidate for review by the Supreme Court.