Severance Payments Are Wages for FICA Purposes, Supreme Court Holds

Supplemental unemployment compensation benefits (SUBs), which include severance payments, are taxable wages for purposes of the Federal Insurance Contributions Act (FICA), the Supreme Court held. In reaching this conclusion, the Court overturned a decision of the Sixth Circuit Court of Appeals (2012-2 ustc ¶50,551).

The taxpayer entered into an involuntary bankruptcy proceeding, before and after which the taxpayer terminated thousands of employees and provided them with severance payments. The Court held that severance payments are included in FICA’s broad definition of wages, defined in Code Sec. 3121(a) as "all remuneration for employment," and confirmed this principle through an analysis of the specific exemptions to this definition and of the statutory history.

Code Sec. 3402(o), which instructs that any severance payment be treated "as if" it were a payment of wages, does not alter the inclusion of severance pay as FICA wages. According to the taxpayer, this instruction is an indirect means of stating that the definition of wages for income tax withholding does not cover severance payments, and therefore severance payments are not covered by FICA’s similar definition of wages. The Court disagreed, holding that severance payments fall within the broad definition of wages for purposes of income-tax withholding under Code Sec. 3401(a), for the same reasons as with FICA’s similar definition of wages.

Code Sec. 3402(o)’s command that all severance payments be treated "as if" they were wages for income tax withholding is consistent with the proposition that at least some severance payments are wages. The Court also disagreed with the taxpayer’s contention that the boldface heading inCode Sec. 3402(o) must be read to require that SUB pay be exempt from FICA.

The regulatory background against which Code Sec. 3402(o) was enacted illustrates the limited nature of the problem the provision was enacted to address, relating to income tax withholding and the ability of employees to receive state unemployment benefits. The congressional decision to include within Code Sec. 3402(o) a larger set of SUBs than was already exempt from withholding under IRS rulings must most reasonably be read as a determination that, whatever position the IRS took with respect to certain categories of severance payments, the problem with withholding should be solved by treating all severance payments as wages requiring withholding.

Finally, if the Court had ruled that the severance payments were exempt from FICA taxation but not from withholding for income tax purposes, it would have contravened the holding in Rowan Cos. Inc., SCt, 81-1 ustc ¶9479, which held there should be congruence in the rules for FICA and income tax withholding.