On March 25, 2014, in US v. Quality Stores, Inc., the US Supreme Court unanimously held that severance payments are taxable wages for purposes of the Federal Insurance Contributions Act (FICA) (12-1408, (U.S. March 25, 2014)).

In connection with its bankruptcy proceedings, the employer, Quality Stores, Inc., terminated thousands of employees and paid them severance payments resulting from reductions in force and plant shutdowns. The payments, which varied by the employee's job seniority and function, were made under two different termination plans:

The employer reported the severance payments as Form W-2 wages, paying its share and withholding its employees' share of FICA taxes. However, the employer later filed for a refund of over $1,000,000 in FICA taxes, and when the IRS failed to allow the claim, the employer sought a refund of the disputed amount in its bankruptcy proceedings. The bankruptcy court ruled in the employer's favor and both a district court and the US Court of Appeals for the Sixth Circuit affirmed, concluding that severance payments are not wages under FICA. The government appealed and the Supreme Court granted certiorari to resolve a circuit split regarding whether FICA taxes must be withheld on severance payments.

Reversing the Sixth Circuit, the Supreme Court held that the employer's severance payments were taxable wages under FICA's broad definition of "wages." The Court reasoned that:

Emphasizing the connection between severance payments and the employment relationship, the Court reasoned that:

The Court noted that its conclusion was reinforced by a specific FICA-related exemption in IRC Section 3121(a)(13)(A) for severance payments due to retirement for disability (26 U.S.C. § 3121(a)(13)(A)). That exemption would be unnecessary if severance payments did not fall under FICA's definition of wages as a general rule.

In addition, the Court rejected the employer's argument that a related IRC provision governing income-tax withholding operated, by extension, to exclude severance payments from the definition of wages for FICA purposes. Under IRC Section 3402(o), all severance payments are treated "as if" they are wages for purposes of income-tax withholding, including:

(26 U.S.C. § 3402(o).)

The employer argued that because IRC Section 3402(o) treated SUBs "as if" they were wages, it should be interpreted to mean that the definition of wages for income-tax withholding purposes (and, therefore, for FICA purposes) does not cover severance payments generally. The Court disagreed, however, concluding that Congress intended IRC Section 3402(o) to eliminate the differential treatment under which:

As a result, the IRC provision did not narrow the scope of wages under FICA to exempt all severance payments.

The Supreme Court's ruling brings clarity on this issue. Any employer that did not, before this case, withhold for FICA on severance payments, should:

Also, the Court appears to call into question whether the IRS' existing exemption from FICA tax for SUB plans is consistent with the broad definition of wages under FICA, and effectively invites the IRS to revisit its position on SUB plans.