March 25, 2014
Employers sometimes provide severance pay to departing employees, whether as part of a severance pay plan or policy, an individual separation agreement or to settle a dispute between the employer and the departing employee. While the recipient of the severance pay is a former, not current, employee, the payment is considered “wages” for Oregon and federal income tax and withholding purposes, and is reportable on IRS Form W-2 (not 1099-MISC).
Years ago, a dispute arose between employers and the Internal Revenue Service over whether severance pay also is “wages” subject to FICA (Social Security and Medicare) taxes and withholding. The Federal Circuit Court of Appeals in Washington D.C., agreeing with the IRS, held that severance pay is wages for FICA purposes. More recently, the Sixth Circuit Court of Appeals in Cincinnati, agreeing with an employer, Quality Stores, held that severance pay is not wages for FICA purposes. Notwithstanding the Sixth Circuit decision, we have generally advised employers to treat severance pay as wages for FICA purposes.
This morning, the United States Supreme Court, in a unanimous decision in United States v. Quality Stores, resolved the split in the circuits, agreeing with the IRS that severance payments generally are wages subject to FICA taxes and withholding.
There is still one type of severance pay that is not subject either to income tax withholding or to FICA taxes and withholding. That is payments from a Supplemental Unemployment Benefit (SUB) Plan, which are designed to supplement and are tied to the receipt of state unemployment benefits. The Court recognized that the IRS has specifically exempted those benefits, which were not at issue in the Quality Stores case. Whether the IRS continues its exemptions for SUB benefits remains to be seen.
Employers who have paid severance pay and either failed to pay and withhold FICA taxes,
or have paid and withheld such taxes and filed refund claims, will want to consult their tax
advisors. As ever, we hope employers will feel free to contact us at any time about these
and any other labor, employment, or benefits issues.