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A Better Partnership


Apr 2014
April 04, 2014

Supreme Court Overturns Sixth Circuit: Severance Payments ARE Taxable FICA Wages

Employers who filed refunds claiming that severance payments for involuntary reductions in their workforce were not subject to taxation under the Federal Insurance Contributions Act (FICA), likely will have their claims denied. In U.S. v. Quality Stores, Inc., the United States Supreme Court held that severance payments are indeed taxable wages for FICA purposes. Its decision reversed the Sixth Circuit’s prior holding that severance payments are not taxable as FICA wages.


In connection with a bankruptcy reorganization, Quality Stores closed all of its stores and distribution centers and terminated all of its employees. Quality Stores made severance payments to those whose employment was involuntarily terminated. Because the severance payments were gross income to the employees for federal income tax purposes, Quality Stores reported the payments as wages and withheld income tax. Quality Stores also withheld each employee’s share of FICA tax and paid the employer’s share.

Although Quality Stores collected and paid the FICA tax, it did not agree with the Internal Revenue Service (IRS) that the severance payments were wages for FICA purposes. Instead, it took the position that the payments made to its employees were not wages but instead were supplemental unemployment benefits (SUB) payments not taxable under FICA.

The Sixth Circuit reasoned that the payments satisfied the five-part statutory definition of SUB payments, and, because SUB payments are not wages for federal income tax purposes (even though they are subject to income tax withholding), they are not wages for FICA taxes.


In reversing the Sixth Circuit’s decision, the Supreme Court addressed several issues:  (1) whether the Internal Revenue Code (IRC) income tax withholding rules apply to severance payments, (2) whether FICA’s definition of “wages” includes severance payments and (3) the differences between severance payments versus SUB payments.

Income Tax Withholding Rules

Quality Stores argued that the definition of wages for income tax withholding does not cover severance payments and, because of that, severance payments are not covered by FICA’s similar definition of wages. The Supreme Court disagreed. Instead, the Court stated that the definitional section for income tax withholding contains a series of specific exemptions and severance payments are not included in the list of exemptions. Accordingly, the Supreme Court found that severance payments are subject to income tax withholding.

FICA’s Definition of “Wages”

Under FICA, the Supreme Court explained that “wages” are defined broadly and encompass “all remuneration for employment.”  The Supreme Court discussed that severance payments are made to employees only in consideration for services provided to the employer. The Supreme Court further explained that FICA’s definitional section provides a lengthy list of specific exemptions from the definition of wages, like the definitional section for wages for income tax withholding purposes, and severance payments are not included in the list of exemptions. Accordingly, the Supreme Court found that FICA’s definition of “wages” includes severance payments.

Severance Payments versus SUB Payments

The Supreme Court next discussed the difference between SUB payments and severance payments. The Supreme Court explained that SUB payments are a type of severance payment. The Supreme Court then discussed the history of SUB plans.

SUB plans were originated in the 1950s in labor demands for a guaranteed annual wage. A SUB plan, as originally conceived, offered second-level protection against layoff by supplementing unemployment benefits offered by States. But, for these SUB plans to work, it was necessary to avoid having SUB plans defined under federal law as “wages”  because some States only provided unemployment benefits if terminated employees were not earning “wages.”

In response, the IRS promulgated guidance that took the position that SUB payments were not wages for either income tax withholding purposes or FICA. These SUB payments were, however, still considered taxable income. As a result, terminated employees faced significant tax liability at the end of the year. In 1969, Congress addressed this issue by amending the IRC to provide that all severance payments, both SUB payments as well as severance payments that the IRS considered wages, were to be treated as if they were wages for income tax withholding purposes. The problem Congress sought to resolve was not to change the FICA and withholding requirements for other types of severance payments, but the prospect that terminated employees would owe large tax payments at the end of the year as a result of the IRS exemption of SUB payments from withholding.

The Court then concluded that because the severance payments from the Quality Stores severance programs were not linked to the receipt of State unemployment benefits, they were not SUB payments and, therefore, were taxable wages subject to FICA.


Taxpayers that went to the expense of filing claims should consider whether their severance payments qualify as SUB payments as described in the Supreme Court’s decision. If so, they may wish to consider taking legal recourse. In considering whether to pursue legal recourse, only those severance payments that are clearly SUB payments are likely to succeed in pursuing such remedies.

If you have questions regarding whether your plan should pursue legal action in this context, or regarding FICA and severance payments in general, contact Lisa Zimmer at, Amy Fredrickson at, or any other member of the Warner Norcross and Judd LLP Employee Benefits / Executive Compensation Group.

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