On March 25, 2014, the Supreme Court of the United States unanimously ruled that severance payments ─ that are not linked to the receipt of state unemployment benefits ─ are taxable wages subject to the Federal Insurance Contributions Act (“FICA”). United States v. Quality Stores, Inc., 572 U.S. ___ (2014). Specifically, the Supreme Court ruled that the severance payments made to employees who were terminated involuntarily fit within the broad definition of “wages” under both FICA § 3121(a) and Internal Revenue Code § 3401(a).
As part of Quality Stores’ Chapter 11 bankruptcy, severance payments were made to its employees in amounts that varied based on seniority and time of service. Notably, the severance payments made were not tied to the receipt of state unemployment benefits. After Quality Stores paid and withheld taxes required under FICA, the company determined that the severance payments should not have been taxed as wages and sought a refund. The Bankruptcy Court, District Court, and Sixth Circuit Court of Appeals all ruled in favor of Quality Stores, concluding that severance payments are not wages under FICA. The Sixth Circuit based its decision entirely on the definition of wages set forth by the Internal Revenue Code § 3401(a). The Supreme Court ruled that this interpretation of § 3401(a) was incorrect.
The Supreme Court began its analysis by examining whether the severance payments at issue were wages pursuant to FICA § 3121(a), which defines “wages” as “all remuneration for employment.” “Employment” is defined as “any service . . . performed . . . by an employee.” Under its plain meaning, the Court found severance payments were clearly wages because the amounts paid varied according to the employee’s seniority and time served, which evidences that they were made like any other benefit given to an employee for his/her services. Moreover, the Court found the payments were wages under FICA because the law exempts certain termination-related payments from the definition of wages, including severance payments made because of “retirement for disability,” ─ a provision that would be superfluous if all severance payments were exempt. In addition, relying on its prior decision in Rowan Cos. v. United States, 452 U.S. 247 (1981), the Court ruled that “‘simplicity of administration and consistency of statutory interpretation instruct that the meaning of ‘wages’ should be in general the same for income-tax withholding and for FICA calculations.” Accordingly, the Court held that severance payments “made to employees terminated against their will, [which] were varied based on job seniority and time served, and were not linked to the receipt of state unemployment benefits” constitute taxable wages under FICA.