Are Severance Payments Taxable?

The United State Supreme Court in States v. Quality Stores, Inc. recently addressed the question of whether severance payments are taxable wages under the Federal Insurance Contribution Act (FICA). (Under 26 U.S. Code § 3121.) FICA defines "wages" as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.

In United States v. Quality Stores, Inc. et.al, Quality Stores, Inc. filed for Chapter 11 bankruptcy. As a result of the bankruptcy they had to lay off their employees. The employees were offered severance payments that were based off of seniority and timed served. At the time, Quality Stores, Inc. withheld taxes from the severance payments in accordance to FICA, but later felt that the taxes should have never been withheld in the first place. When the issue was brought up and denied by the IRS, Quality Stores, Inc. took up the issue in Bankruptcy Court. The decision from Bankruptcy Court, the District Court and the Court of Appeals for the Sixth Circuit all concluded that severance payments are not taxable under FICA.

The Supreme Court reversed the decision. The Court concluded that 26 U.S. Code § 3121, defines " wages" as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash." The opinion goes on to state that "Under this definition, and as a matter of plain meaning, severance payments made to terminated employees are "remuneration for employment." Severance payments are payments made to the employee for their service. Under the definition that is provided by FICA, severance payments are considered a "remuneration for employment" and constitute taxable wages.

Terminating an employee involves several decisions of the employer regarding the rights and obligations of the employer and the employee. If you find you are not sure on the steps to take in terminating / letting go an employee, give us a call at 866-439-1295 or email us at [email protected]