Supreme Court to Determine Whether Severance Pay is Taxable

Supreme Court to Determine Whether Severance Pay is Taxable

The U.S. Supreme Court has agreed to explore whether companies and employees must pay Federal Insurance Contributions Act (FICA) taxes on severance compensation. The results of the ruling could force the U.S. Department of Treasury to pay out roughly $1 billion in tax refund claims.

The case centers around a dispute between bankrupt Quality Stores Inc. and the Internal Revenue Service. The company, which went under in 2001 and closed all 300 of its stores, was forced to lay off 3,100 workers. However, Quality Stores made severance payments to each laid-off worker and paid FICA taxes on the amounts. In 2002, the company claimed a $1.1 million refund with the IRS for the taxes paid, arguing that severance payments do not count as wages, and are therefore not subject to payroll taxes.

Employers and employees each pay 6.2 percent in Social Security taxes on wages, and some of the refund money – if awarded – will go to employees, who allowed the company to lobby for the funds on their behalf. The IRS disagreed with the claims and refused to distribute refunds. “The severance payments at issue here are clearly ‘wages’ for FICA purposes,” the government said in an August filing, according to Reuters. The tax law case is particularly important, as Americans continue to be laid off and may be unsure of their tax obligations when it comes to severance, paid-out PTO days, and bonuses. The IRS currently defines wages broadly to include compensation for services of any type for FICA tax purposes, Bloomberg notes.

Therefore, if the Supreme Court chooses to place restrictions on this law, the Treasury Department may face a barrage of refund claims from companies and employees who previously made FICA payments on severance packages after being laid off.