By Robert A. Linch

In the recent ruling US v. Quality Stores, Inc., the Supreme Court declared that severance packages paid to employees are subject to the FICA tax (a 15.3% tax imposed on all income, paid in equal parts by employers and employees, that funds Social Security and Medicare). While severance packages (or supplemental unemployment compensation benefits, “SUB” payments) have always been subject to federal income tax, the new ruling states that severance payments constitute “wages” within the meaning of the FICA statute and therefore are taxable under FICA in addition to regular income tax. Previously, the lower Circuit courts were split on the definition of wages and if SUB payments were subject to FICA; the third Circuit Court ruling in CSX Corp. v. US, that severance payments are “wages” and subject to FICA tax, and this 6th Circuit case which ruled that severance payments were not “wages” and therefore not subject to FICA.


The Supreme Court disagreed with the 6th Circuit and reversed its ruling based on the statutory text and legislative history of the term “wages” under FICA. The Supreme Court rejected the lower court’s definition of severance payments not being “wages” within the meaning of the FICA statute. The question, as the Court interpreted it, was whether severance packages should be considered compensation for employment, with wages defined as compensation for services performed by an employee for an employer. The Court reasoned that severance packages were indeed compensation for employment, citing the fact that SUB payments are generally tied to a number of employment related factors such as the employee’s function, title, and tenure and therefore severance payments are connected to the employee’s service in employment.


The Supreme Court concluded its opinion by issuing a cautionary warning to the IRS regarding the inconsistency of the regulations related to FICA taxation on SUB payments. The position of the IRS has been that SUB payments are wages (and taxable under FICA) when tied to eligibility for state unemployment benefits. Some state laws make those who receive “wages” ineligible for unemployment benefits, which invalidate much of the benefit of receiving severance payments in the first place. To avoid this problem the IRS has embraced the definition of severance payments as wages being dependent on how they are tied to state unemployment benefits. SUB payments in this particular case were not tied to unemployment benefits so the Court did not address the question of whether the regulations and revenue rulings were logically consistent or rational. It does seem, however, that the Supreme Court does question the position of the IRS, which may affect future regulations.


The attorney representing Quality Stores called the decision, “a huge blow for employers and employees alike.” The Justice Department was pleased that the Court recognized no difference in how severance pay is taxed for FICA and viewed the ruling as a victory. Essentially, what this means for those evaluating a severance package offer, is that the FICA tax should be taken into consideration in addition to the regular income tax implications arising from the receipt of severance payments.