The Supreme Court recently ruled in U.S. v. Quality Stores that severance paid to employees is considered wages for FICA purposes. Before the Court’s decision, there was little doubt that employer-provided severance was wages for income tax purposes, but lower court cases were a mixed bag about whether severance was wages for FICA tax purposes. Indeed, the Sixth Circuit in Quality Stores, held that the severance payments made by Quality Stores were not wages for FICA tax purposes because the payments fell within the statutory exclusion for Supplemental Unemployment Benefit (“SUB”) payments for FICA tax purposes. The Supreme Court upheld the IRS’ position and disagreed with the Sixth Circuit’s analysis. As a result of the Supreme Court’s reversal of the Sixth Circuit case, most typical employer-provided severance benefits are likely subject to both income and FICA taxes.
However, there may nevertheless be certain advantages for employers to specifically structure their severance payments as SUB payments, which are exempt from FICA taxes. For severance payments to qualify as SUB payments, the following conditions must be met:
- The employee is laid off by the employer either in an involuntary permanent or temporary reduction in force or in a temporary layoff (employees who voluntarily quit or whose employment is terminated for misconduct are not eligible);
- The severance payments are contingent on the employee being eligible to receive state unemployment insurance benefits; and
- The severance payments must be paid in installments and cannot be paid as a lump sum.
If the employer can meet the above criteria for paying severance, the payments are exempt from FICA tax (employer and employee portions) and the employer may be able to reap a savings by coordinating the severance payments with state unemployment benefits. If you have any questions about these issues, please do not hesitate to contact Bucky Swift at (602) 382-6211, or any other member of the Employee Benefits and Executive Compensation Group.