Posted by: Barbara Theofilos, CPA
Are severance payments subject to Federal Insurance Contributions Act (FICA) taxes? A simple “yes” or “no” answer would be too simple. The answer to this question depends upon who you ask.
The Sixth Circuit Court of Appeals concluded that severance payments made to terminated employees from Quality Stores are not subject to Social Security and Medicare, also known as FICA taxes. This determination was made in September 2012 and contradicts the Federal Circuit Court of Appeals’ conclusion arrived at in 2008 for CSX Corp.
The Sixth Circuit ultimately determined that these payments are not considered wages if they meet the criteria of “supplemental unemployment benefits.” These payments must meet all of the following criteria:
1.) Paid to an employee
2.) Pursuant to the employer’s plan
3.) Due to the recipient employee’s involuntary separation from employment
4.) Directly due to a reduction in force, discontinuance of a plant or operation, or other similar conditions
5.) Included in the recipient employee’s gross income
On the other hand, the Federal Circuit of Appeals had the exact opposite opinion when they concluded that “supplemental unemployment benefits” following the same criteria listed above actually are considered wages and therefore subject to FICA taxes.
The Internal Revenue Service has consistently taken the same stance as the Federal Circuit of Appeals that the severance payments are considered wages. According to the IRS, the only situation in which these payments are not subject to FICA taxes is when the payments are linked to state unemployment compensation benefits.
While this issue is still being resolved, Quality Stores and their employees have the ability to enjoy the benefits of not paying the additional FICA taxes on the future severance payments. Both the employer and employees are also allowed to request refunds for any FICA taxes that were paid in previous years. The IRS will likely hold onto those refunds until a final decision is made by the Supreme Court. In the meantime, the employers and employees of Quality Stores will continue to reap the benefits of avoiding the additional FICA taxes on their future severance payments.
