Supreme Court Rules Severance Payouts are Taxable

By: Caitlin Esposito

Last Tuesday, the Court published its opinion in United States v. Quality Stores, Inc.  The unanimous opinion by Justice Kennedy held that severance payments to employees involuntarily terminated are taxable wages under the Federal Insurance Contributions Act (FICA).[1]  Prior to filing for bankruptcy in 2001, Quality Stores terminated thousands of its employees.[2]  All of these employees received severance payouts.[3]  Quality Stores reported these severance payments as wages on their W-2 Tax Forms and paid the employer’s required share of FICA taxes, but withheld employees’ shares of FICA taxes.[4]  The former employees granted Quality Stores permission to file FICA tax refund claims for them, resulting in Quality Stores filing for a refund of $1,000,125.[5]   The Internal Revenue Service (IRS) did not respond to the claim and Quality Stores initiated a proceeding in Bankruptcy Court seeking a refund of the amount.[6]  Quality Stores argued that severance payments do not qualify as wages and are therefore not taxable under FICA.[7]  The Bankruptcy Court granted summary judgment in its favor.[8]  The District Court and Court of Appeals for the Sixth Circuit affirmed, concluding that severance payments are not wages under FICA.[9]

FICA defines wages as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.”[10]  Employment means “any service, of whatever nature, performed by an employee for the person employing him.”[11]  Under this broad definition, severance payments made to terminated employees are remuneration for employment.  Furthermore, the FICA provides specific exemptions from the definition of wages.[12]  These exemptions reinforce the broad nature of FICA’s definition of wages.[13]

The Court went on to examine sections of the Internal Revenue Code (IRC) to determine if income-tax withholding is a limitation on the meaning of wages.[14]  The IRC states 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 for a payroll period.”[15]  Wages are defined as “all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash.”[16]  The IRC contains specific exemptions that reinforce the broad scope of its definition of wages.[17]  Severance payments are not exempted and fall within the broad textual definition of wages for purposes of income-tax withholding.[18]

Since severance payments fall within these broad definitions of wages under FICA and the IRC, they are taxable.[19]  Any other interpretation of these definitions would “disserve the statutory text and the congressional interest in administrative simplicity.”[20]

 

[1]  See United States v. Quality Stores, Inc., No. 12-1408, 2014 BL 80719 (U.S. Mar. 25, 2014).

[2] See id.

[3] See id.

[4] See id.

[5] See id.

[6] See Quality Stores, 2014 BL 80719.

[7] See id.

[8] See id.

[9] See id.

[10] 46 U.S.C. § 3121(a) (2006).

[11] 46 U.S.C. § 3121(b) (2006).

[12] 46 U.S.C. § 3121(a).

[13] See id.

[14] See United States v. Quality Stores, Inc., No. 12-1408, 2014 BL 80719 (U.S. Mar. 25, 2014).

[15] 26 U.S.C. §3402(o)(1)(A) (2006).

[16] 26 U.S.C. §3401(a) (2006).

[17] See id.

[18] See Quality Stores, 2014 BL 80719.

[19] See id.

[20] Id.

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