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U.S. Supreme Court Rules that Severance Payments are Considered Wages

Quality Stores was in financial trouble in 2001 when it began offering its employees severance packages. The question presented in United States v. Quality Stores, Inc. was whether severance payments from employers to employees constitute “wages” under the Federal Insurance Contributions Act (FICA). FICA is a mandatory federal payroll tax imposed on employers and employees. Taxes collected under FICA fund Social Security and part of the Medicare program.

Severance payments are unquestionably income under the income tax, but the issue of whether payments to employees terminated against their will constituted “wages” for purposes of payroll tax was more complicated. The Sixth Circuit had concluded that severance payments were not wages based on statutes regarding employers’ income-tax withholding obligations. However, the Supreme Court focused on the relevant portion of FICA that defined the term “wages” as all remuneration for employment. Moreover, FICA defines employment as any service whatsoever performed by an employee.

The Supreme Court reversed the Sixth Circuit in Quality Stores, holding that severance payments by employers fall within the definition of “wages” for purposes of FICA. If the Sixth Circuit had been affirmed, the IRS would need to refund more than $1 billion. The Court ruled that severance payments constitute wages for the following reasons:

  • Severance payments are paid to employees or former employees, and they are typically based on the person’s position with the company and how long he or she was employed.
  • The Court found that severance payments are similar to other non-salary benefits like stock options, health benefits, and merit-based bonuses, all of which are indisputably remuneration.
  • Justice Kennedy also noted that severance payments due to retirement or disability are specifically exempted from the definition of wages, which would be unnecessary if severance payments were not typically considered wages for purposes of FICA.
  • In 1950, Congress specifically repealed a provision stating that wages did not include dismissal payments within the context of the Social Security Act. Congress has made no further amendments.

If you are a business owner with questions about complying with tax laws, contact an experienced Washington D.C. attorney who can answer your questions and provide skilled legal guidance.

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