In United States v. Quality Stores, Inc., ___ U.S. ___ (March 25, 2014), the United States Supreme Court reversed the ruling of the United States Court of Appeals for the Sixth Circuit holding that severance payments are not taxable wages under the Federal Insurance Contributions Act (“FICA”).

Respondent, an agricultural specialty retailer, made severance payments to thousands of employees who were involuntarily terminated in 2001 and 2002 as part of its Chapter 11 bankruptcy.  As is typical, the amount of each employee’s severance payment varied, depending upon the employee’s position and length of service. When the payments were made, respondent withheld over $1 million in Social Security and Medicare taxes required by FICA. Later believing that the payments should not have been taxed as FICA wages, respondent sought a refund on behalf of itself its former employees, which the Internal Revenue Service denied.  Accordingly, respondent initiated proceedings in the Bankruptcy Court, which granted summary judgment in its favor. The United States appealed that decision but the U.S. District Court for the Western District of Michigan and Sixth Circuit both affirmed, concluding that severance payments are not wages under FICA. The United States appealed again.

The U.S. Supreme Court reversed, finding that the severance payments in questions were taxable under FICA.  The court noted that FICA defines “wages” broadly as “all remuneration for employment.” In this instance, the severance payments were a form of remuneration made only to employees in consideration for their employment. “The severance payments here were made to employees terminated against their will, were varied based on job seniority and time served and were not linked to the receipt of state unemployment benefits.”  Therefore, “under FICA’s broad definition, these severance payments constitute taxable wages.” Similarly, the Internal Revenue Code chapter governing income-tax withholding also has a broad definition of “wages” and does not contain any specific exemptions that would apply to the severance questions at issue.