The IRS recently announced that severance payments are taxable wages under FICA, and thus employers who seek tax refunds on those payments will be denied. The IRS's position reflects the United States Supreme Court's ruling in United States v. Quality Stores, Inc., issued in March of last year.
Quality Stores, Inc. entered into bankruptcy proceedings in 2001 and terminated thousands of employees. The company offered the employees a variety of severance plans depending on the position in the company and years of service (but importantly, not the receipt of state unemployment compensation). Quality Stores reported the severance payments as wages, paid its required share of FICA taxes, and withheld the employees' share of FICA taxes. Later, under the premise that the severance should not have been taxed as wages under FICA, the company filed for a refund of the more than $1 million dollars in FICA taxes it paid on its own behalf and on behalf of the former employees.
The Internal Revenue Service effectively denied the request and Quality Stores took the issue all the way up to the Sixth Circuit. The Sixth Circuit agreed with Quality Stores and held that the payments were not wages for FICA purposes, and thus the company was entitled to a refund of the FICA taxes. The Supreme Court reversed the Sixth Circuit and held that the severance payments at issue are taxable wages for FICA purposes.
As a practical matter, not much has changed for employers outside of the Sixth Circuit's jurisdiction—the IRS notes in Announcement 2015-08 that it previously disallowed all such claims for refund of FICA taxes on severance payments from taxpayers outside of the Sixth Circuit and the ruling in Quality Stores merely eliminates the carve-out. The IRS will continue to disallow all claims for refund of FICA taxes from severance payments, subject to the narrow exception for certain payments linked to state unemployment benefits found in Revenue Ruling 90-72.
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