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Refunds Possible if Severance Pay is Ruled Not Taxable by the Supreme Court


The recession is still having long-lasting effects on businesses. If you own or owned a business that laid off employees in 2007-09 and paid them severance or received severance yourself, you’ll want to keep your eye on an upcoming court case. The Supreme Court is scheduled to begin hearing arguments in mid-January 2014 in the case of United States v. Quality Stores, Inc., regarding the taxability of severance payments. Specifically in question is whether severance pay is considered wages for the purpose of the Federal Insurance Contributions Act tax (FICA).  FICA is paid by both the employer and employee, and consists of a 6.2% payroll tax for Social Security and 1.45% tax for Medicare.

The case is being heard by the Supreme Court after the 6th U.S. Circuit Court of Appeals sided with a U.S. district court in western Michigan, ruling in 2012 that both Quality Stores Inc. and its former employees could claim a refund from the Internal Revenue Service. That contradicted an earlier ruling from the Court of Appeals of the Federal Circuit, which allowed severance pay to be taxed for FICA.

A decision is expected as early as June 2014. If the Supreme Court rules against the IRS, severance pay would not be considered wages and would be exempt from taxation. In that case, the IRS would owe substantial refunds to taxpayers — close to $1 billion.

Until the ruling, businesses should continue to withhold FICA taxes from severance payments.

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