Employers' Huge Tax Refund Hopes Dashed by Supreme Court Severance Pay Ruling

Apr 4 2014, 4:59pm CDT | by

The Supreme Court’s unanimous reversal of the pro-employer, 2013 Sixth Court decision in U.S. v. Quality Stores Inc., has quashed any prospect of big tax refunds to employers for their past severance payouts to laid-off workers.

As we reported here in October, the Sixth Circuit ruled that severance payments to involuntarily severed employees were not taxable under FICA. Had the Supreme Court agreed, teams of employers would be due refunds for their FICA contributions in connection with severance payouts made during layoffs in the Great Recession. Unfortunately, the High Court reversed.

The Court ruled that severance payments employers made to involuntarily laid-off employees are “wages” and are taxable under FICA. The Court based its decision on an analysis of (1) the definition of “wages” in FICA—a statute that taxes “wages” paid by an employer or received by an employee “with respect to employment,” to fund Social Security and Medicare benefits—and (2) Internal Revenue Code (IRC) § 3402(o)—which governs income-tax withholding.

  1. As to the FICA definition—that “wages” means “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash,” FICA § 3121(b)—the Court held that severance payments are, “of course, ‘remuneration,’” and that “common sense dictates that employees receive the payments ‘for employment.’”
  2. As to IRC § 3402(o)—which provides that “any supplemental unemployment compensation benefit paid to an individual shall be treated as if it were a payment of wages by an employer to an employee” (emphasis added)—the Court rejected the Sixth Circuit’s ruling that the “as if” language meant severance payments were not covered by FICA’s “wages” definition.

But there is a silver lining. Employers will no longer face different tax requirements depending on where their severed employees worked. The High Court’s ruling resolves the inconsistency between lower courts that the Sixth Circuit’s Quality Stores decision created—as it was in direct odds with a Federal Circuit’s 2008 decision that severance payments are taxable under FICA (in a case titled CSX Corp. v. U.S.). In addition, the Supreme Court’s Quality Stores decision is consistent with the IRS’ long-held position on the taxability of severance payments, as well as with most employers’ current and long-term practices in compliance with that IRS position.

The Takeaway: No tax refunds on the horizon, but clear guidance and certainty for the future.

Copies of U.S. v. Quality Stores Inc., et al., No. 12-1408, 2014 WL 1168968 (March 25, 2014), and the two Circuit Court decisions the Supreme Court has reconciled—CSX Corp., et al. v. U.S., 518 F.3d 1328 (Fed. Cir. 2008), and U.S. v. Quality Stores Inc., et al., 693 F.3d 605 (6th Cir. 2013)—are available here, here and here, respectively.


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