Employee Benefits-Supreme Court Rules That Severance Payments Are Wages Subject FICA Tax

In United States v. Quality Stores, Inc., No. 12-1408 (S.Ct. 2014), Quality Stores, Inc. and its affiliates (collectively “Quality Stores”) made severance payments to employees who were involuntarily terminated as part of Quality Stores’ Chapter 11 bankruptcy. Payments-which were made pursuant to plans that did not tie payments to the receipt of state unemployment insurance-varied based on job seniority and time served. Quality Stores paid and withheld FICA taxes on the payments, treating the payments as wages. Later believing that this treatment, and payment and withholding of FICA taxes, was not correct, Quality Stores sought a refund from the Internal revenue Service (the “IRS”) on behalf of itself and about 1,850 former employees. When the IRS did not allow or deny the refund, Quality Stores initiated proceedings in the Bankruptcy Court, which granted summary judgment in its favor. The District Court and Sixth Circuit affirmed, concluding that severance payments are not wages under FICA.

The Supreme Court reversed the decisions of the lower courts, holding that the severance payments are wages subject to FICA tax. The Supreme Court said that FICA defines “wages” broadly as “all remuneration for employment.” IRC §3121(a). As a matter of plain meaning, severance payments fit this definition: They are a form of remuneration made only to employees in consideration for employment. “Employment” is “any service . . . performed . . . by an employee” for an employer. IRC §3121(b). By varying according to a terminated employee’s function and seniority, the severance payments at issue confirm the principle that “service” “mea[ns] not only work actually done but the entire employer-employee relationship for which compensation is paid.” Social Security Bd. v. Nierotko (S.Ct.) This broad definition is reinforced by the specificity of FICA’s lengthy list of exemptions, none of which apply in the instant case.

The Supreme Court added that the Internal Revenue Code’s provisions for income-tax withholding would similarly treat the severance payments at issue as wages. Consistent with the major principle of Rowan Cos. v. United States (S.Ct.), for simplicity of administration and consistency of statutory interpretation, the meaning of “wages” should be in general the same for income-tax withholding and for FICA calculations.