Is the Severance that Your Company Pays to Fired Workers Taxable? The Supreme Court Will Decide

On October 1, 2013, the Supreme Court of the United States agreed to hear a case concerning whether employees’ severance payments are taxable. The case, United States v. Quality Stores, Inc., came out of the Sixth Circuit Court of Appeals on appeal from a bankruptcy court in which Quality Stores, Inc. sought a tax refund from the United States for $1,000,125 in taxes paid under the Federal Insurance Contributions Act (FICA). The company, which had been pulled into bankruptcy and later reorganization, challenged a requirement to pay Social Security and Medicare taxes on the severance that it had paid its workers. The Sixth Circuit had held that severance paid to employees on account of an involuntary reduction in force is not subject to FICA taxes. This decision created a split among the circuit courts on this issue—making it likely that the Supreme Court would grant certiorari in the case as predicted in a March 2013 article. According to the Internal Revenue Service (IRS), severance is subject to FICA tax and certain supplemental unemployment benefits are not. For more information about the IRS’s position on severance, supplemental unemployment benefits, and Quality Stores, refer to parts one and two of our blog series, “The Advantages of Offering Supplemental Unemployment Benefits Instead of Severance.”

On review, the Supreme Court will ultimately settle the question of whether severance payments made to employees whose employment is involuntarily terminated are taxable under FICA. Oral arguments in the case and the Court’s decision are due in the Court’s coming term, which starts on October 7 and ends in June 2014.