Legal Briefings: For Severance Pay, Companies Have to Pay Taxes

Quality Stores Inc. made severance payments to employees who were involuntarily terminated as part of its Chapter 11 bankruptcy. Quality Stores paid and withheld taxes required under the Federal Insurance Contributions Act, or FICA, but later sought a refund from the U.S. Internal Revenue Service on behalf of itself and about 1,850 employees believing that the payments should not have been taxed as wages under FICA.

When the IRS neither allowed nor denied the refund, Quality Stores initiated proceedings in bankruptcy court, which allowed the refund and held the payments were not taxable as wages. Both the federal district court and the U.S. Court of Appeals for the 6th Circuit affirmed the decision.

The Supreme Court reversed and held that severance payments were taxable because FICA’s definition of wages includes “severance payments made to terminated employees.” United States v. Quality Stores Inc., U.S., No. 12-1408 (March 25, 2014).

IMPACT: Employers paying terminated employees under a severance plan may be required to pay and withhold FICA taxes.