Wednesday, September 19, 2012

FICA Tax on Severance Payments

In United States v. Quality Stores, Inc.  the United States Court of Appeals for the Sixth Circuit (Michigan, Ohio, Kentucky, Tennessee) ruled that supplemental unemployment benefit payments (severance payments) are not subject to FICA (social security and medicare) taxes.  By statute Supplemental unemployment benefit payments are not wages and are only treated as wages for federal income tax withholding only. 

While the government argued that an explicit exemption from withholding was required for income to not be subject to the FICA tax, the court disagreed.  It held that as the benefits were not wages they could not be subject to FICA withholding as there was no explicit allowance for withholding as there was for federal income taxes.  The severance payment could not be compensation for services rendered.  Instead they must be compensation for the loss of employment and must be contingent on the loss of employment whether temporary or permanent. They are still subject to federal and state income taxes.

As half of the FICA tax is paid by the employer and half by the employee both the employer and the employee stand to recover a refund.  In this case Quality Stores sought a one million dollar refund.  The government's total liability could be over four billion dollars. 

The federal circuit concluded that severance payments were subject to FICA taxes in 2008 so there is now a circuit split on this issue and the government will likely request a hearing en banc before the entire Sixth Circuit.  The case may be ripe for review by the United States Supreme Court.  Given the amount the government might have to refund if this decision stands an appeal is likely.  The government had argued that congress had "decoupled" withholding of federal income tax from withholding of FICA taxes in 1983 and that income not subject to withholding for federal income taxes was not

s/ Kurt Koehler
308 1/2 S. State Street Suite 36
Ann Arbor, Michigan 48198
(Washtenaw County)