Supreme Court Clarifies Employer FICA Withholding Obligations for Severance Payments in U.S. v. Quality Stores Inc.
Is an employer generally required to withhold and pay FICA taxes on amounts that it pays to separated employees under a severance plan? In most cases, the employer should withhold FICA from severance payments, but it has been unclear whether an employer must withhold FICA on payments made under a severance plan where those payments were not linked to unemployment compensation. In a March 25th decision, the Supreme Court ruled that payments from a severance plan that is not directly linked to state unemployment benefits are “wages” for purposes of FICA and are thus subject to withholding.
In the case, the employer filed for bankruptcy and made severance payments to its employees from two of its severance plans. These supplemental unemployment compensation benefit plans (or “SUB” plans) provided severance benefits that were generally tied to job grade and management level. The employer initially paid FICA taxes on the severance amounts but later reconsidered and requested a refund from the IRS. It argued, among other things, that the general tax withholding and FICA tax rules in the Internal Revenue Code had been drafted by Congress with the intent to broadly exempt these types of SUB plan payments from FICA taxes and withholding.
Historically, the IRS had issued rulings exempting certain SUB plan severance payments from FICA taxes. It granted these exemptions on the ground that characterizing such SUB payments as “wages” subject to withholding was problematic because it jeopardized an employee’s ability to simultaneously receive state unemployment compensation and compensation from an employer at the same time. In this case, the employer’s SUB plans had no link to state unemployment payments. Accordingly, the Supreme Court ruled that the SUB payments were wages subject to tax and FICA withholding.
Employers should be aware that the Supreme Court did not issue a blanket rule requiring that employers withhold FICA from all severance payments. Indeed, the opinion leaves open the possibility that payments from a SUB plan that are linked to unemployment benefits may be exempt from FICA withholding. In most cases, however, individual severance payments and payments from employer severance plans are taxable wages and employers should continue to pay and withhold FICA.