Sixth Circuit: Severance Pay Not Subject to FICA Taxes

You may have noticed that the unemployment rate is still pretty high. Though it's down from the October 2009 peak, companies continue to lay off workers.

The Sixth Circuit Court of Appeals issued an opinion last week that could ease the financial burden on flailing businesses facing layoffs: Friday, the court ruled that severance pay is not subject to FICA taxes, Thomson Reuters News & Insight reports.

Quality Stores, the appellant in the case, was the largest agricultural-specialty retailer in the country serving farmers, hobby gardeners, skilled trade persons, and do-it-yourself customers. It became the subject of an involuntary Chapter 11 bankruptcy petition in 2011. In May 2002, the bankruptcy court confirmed the First Amended Joint Plan of Reorganization.

Following the Chapter 11 filing, but before the reorganization plan was approved, Quality Stores closed all of its stores and distribution centers and terminated its employees. The company made severance payments to the employees whose employment was involuntarily terminated. The parties stipulated that the severance payments, which were made in two phases, resulted directly from a reduction in force or the discontinuance of a plant or operation.

Quality Stores paid FICA taxes on the severance payments, but it disagreed with the Internal Revenue Service (IRS) that the severance payments constituted wages for FICA purposes. The Sixth Circuit sided with Quality Stores, concluding that severance pay is actually a supplemental unemployment compensation benefit, (also known as a SUB payment), under the Internal Revenue Code.

The Sixth Circuit's finding that severance pay is not subject to FICA taxes means that Quality Stores -- and other similarly-situated companies -- can claim a refund for the taxes assessed on severance pay. The court's decision, however, creates a circuit conflict: In 2008, the Federal Circuit ruled in CSX Corp. v. United States that severance pay is subject to FICA taxes.

You know what that means: This issue will most likely be resolved in the Supreme Court.

Related Resources:

• United States v. Quality Stores, et al. (Sixth Circuit Court of Appeals)
• Severance Agreements: How Not to Get Sued (FindLaw's Free Enterprise)
• IRS Can Lose Returns, Burden on Taxpayer for Mailbox Rule (FindLaw's First Circuit Blog)