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Your Legal Corner - Client Alert Blog

Severance - Subject To FICA Tax or Not?

Written By: Melissa C. Marsh, Esq., California Attorney, November 2013 Add to Favorites
In United States v. Quality Stores, Inc., 693 F.3d 605 (2012), the U.S. Court of Appeals for the Sixth Circuit affirmed a district court ruling that certain supplemental unemployment compensation benefit (SUB) commonly referred to as severance payments are not wages subject to FICA taxes. The Internal Revenue Service (IRS) petitioned the U.S. Supreme Court for review. On October 1, 2013, The U.S. Supreme Court agreed to hear the case. Oral arguments and a decision are due in the court's coming term (October 7th-June 2014).

In 2002, Quality Stores, Inc. filed an amended return seeking an IRS refund for around $1 million paid in FICA taxes withheld from severance pay. Quality Stores, Inc. argued that severance payments are not payment for services, but rather payments for "the elimination of employment." As such, Quality Stores, Inc. argued that severance payments are not subject to FICA taxes, but rather regular income taxes. Both the district and appellate courts agreed finding that the severance payments that conformed to IRC 3402(o) are not subject to FICA taxes if: (1) made to employees; (2) pursuant to a company plan; (3) due to the employees' permanent separation of employment; (4) resulting directly from a reduction in force, plant closing, or similar closing of a business; and (5) the payments were included in the employees' gross incomes. The IRS disagreed and petitioned the U.S. Supreme Court for review.

In accepting United States v. Quality Stores, Inc. for review, the Supreme Court will reconcile the conflict among the circuits, as the Federal Circuit Court in CSX Corp. v. United States, 518 F. 3d 1328 (Fed. Cir. 2008), which initially held that involuntary layoff payments are exempt from FICA taxes, only if the payment qualifies as "supplemental unemployment compensation benefits" ("SUB Pay") pursuant to IRS Code 3402(o)(2). However, on appeal, the Federal Circuit reversed the Court of Federal Claims holding that involuntary severance payments were in fact wages subject to FICA taxes.

Pending resolution either by the US Supreme Court, or earlier by the promulgation of additional regulations from either the IRS or Congress, employers should continue to withhold and pay FICA taxes on severance payments, and simultaneously file a protective refund claim with the IRS.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that, to the extent this communication concerns any tax matter, it was not written to be (and may not be) relied upon to (1) avoid tax-related penalties under the Internal Revenue Code, or (2) promote, market or recommend to another party any transaction or matter addressed.

Tags: severance
Posted In: Employment Law News  Tax Update 

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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.