Severance Payments Not Considered Taxable Under FICA

On February 23, 2010, the United States District Court for the Western District of Michigan, Southern Division, decided the case of In re: Quality Stores, Inc., et al., Debtors; United States of America v. Quality Stores, Inc., 2010 WL 679136, holding that severance payments made by Quality Stores to employees in connection with store closings are not taxable for purposes of Federal Insurance Contributions Act (FICA) taxation. Specifically, the court found that when severance payments are made because an employee involuntary left the company due to a direct reduction in workforce or the discontinuance of a plant or operation, those payments were not FICA-qualifying “wages.” The basis for the ruling is that severance payments fall within the exception found in 26 U.S.C. § 3402(o)(2) for “supplemental unemployment compensation benefits.”

In reaching this ruling, the District Court reasoned that as a general matter in enacting the FICA provisions of the Tax Code, Congress intended to impose FICA taxes on a broad range of employer-furnished remuneration; however, that purpose is not unlimited. Specifically, the Court pointed out that the statutory sections clearly designate that a line is to be drawn on the taxation of employee financial benefits; otherwise, such benefits become the basis of the very taxes collected to return to the employee as benefits. Ultimately, the Court was persuaded that the severance payments at issue were properly viewed as wage-replacement social benefits, not taxable remuneration for the employee’s services or wages and, therefore, they were not subject to taxation for FICA purposes.

Stay tuned. This issue can be appealed to the Sixth Circuit Court of Appeals by the United States.

Author: Aretta Bernard

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