Court Upholds Ruling That FICA Taxes Do Not Apply to Severance Pay

November 2, 2012
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The Internal Revenue Service may potentially receive requests for billions of dollars in refunds for Federal Insurance Contribution Act taxes – or FICA – due to a recent court decision that upheld a lower court’s ruling.

In U.S. v. Quality Stores, Inc., the U.S. Court of Appeals for the Sixth Circuit agreed with a district court’s earlier ruling, which affirmed that FICA taxes do not apply to non-wage payments made to employees who are terminated or laid off and allocated these payments as a form of severance. After Quality Stores issued severance packages to laid-off employees, the company withheld FICA taxes from the payments and paid its share. However, it later applied for a refund from the IRS, arguing that the payments were not defined as wages under federal law. The IRS declined the refund.

The IRS provides an exemption from FICA taxes for layoff benefits in supplemental benefit plans, under the provision that payments must be attached to unemployment insurance claims and payments. Quality Stores argued that while the payments were not tied to the receipt of state unemployment compensation, the amounts were still not defined as wages because they were provided to former employees for not working, Bloomberg explains.

In her decision, Sixth Circuit Judge Jane Stranch ruled that the process of determining whether wages are payments for FICA tax law purposes is difficult because the rules governing these scenarios are largely undefined. However, she also noted that even though payments related to “involuntary separation, a reduction in force or a similar condition” are included a worker’s adjusted gross income, it does not necessarily mean the payments are FICA taxable, Bloomberg reports.