Supreme Court Rules That Severance Packages Are Taxable

In a judgment released in late March, the Supreme Court ruled that companies must pay taxes on the severance packages of employees who are involuntarily laid off.

The case revolves around Quality Stores Inc., an agricultural-specialty retailer that entered bankruptcy proceedings in 2001, laying off thousands of workers in the process. The company reported the severance payments as wages on W-2 tax forms, paid their required share of FICA taxes, and withheld employees' share of FICA taxes. Then Quality Stores asked 3,100 former employees to allow it to file FICA tax refund claims for them, to which about 1,850 former employees agreed. On its own behalf and on behalf of the former employees, Quality Stores filed for a refund of $1,000,125 in FICA taxes. The Internal Revenue Service neither allowed nor denied the claim.

Upon initiating a proceeding in the Bankruptcy Court seeking a refund of the disputed amount, Quality Stores was granted summary judgment in its favor. The District Court and Court of Appeals for the Sixth Circuit affirmed, concluding that severance payments are not "wages" under FICA.

However, as Justice Kennedy writes in the Supreme Court ruling, “The severance payments here were made to employees terminated against their will, were varied based on job seniority and time served, and were not linked to the receipt of state unemployment benefits. Under FICA's broad definition, these severance payments constitute taxable wages. The judgment of the Court of Appeals for the Sixth Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion.”