The U.S. Supreme Court finally rendered its decision in U.S. v. Quality Stores, Inc., 572 U.S. ____ (2014), on March 25, 2014, in a closely watched tax case. The Supreme Court reversed the Sixth Circuit Court of Appeals, and found that severance pay is to be considered wages, and therefore subject to Federal Insurance Contribution Act (“FICA”) taxes.
This holding dashed the expectations created by the Sixth Circuit’s holding that severance pay was not subject to FICA taxes. Many businesses had already filed refund claims based on the Sixth Circuit decision, and many more were in the process. Those refund claims are now most likely going to be denied.
The taxpayer, Quality Stores, Inc., paid severance to hundreds of employees while undergoing Chapter 11 bankruptcy reorganization. In its originally filed payroll tax returns, the taxpayer paid roughly $1 million of FICA tax on those severance payments. It later sought a refund of those payments while in bankruptcy, which then placed jurisdiction with the U.S Bankruptcy Court, rather than the U.S. Tax Court. That jurisdictional position seemed to work in the taxpayer’s favor, as the Bankruptcy Court found in favor of the taxpayer, as did the Michigan District Court on review of the decision.
The Sixth Circuit then took up the case on appeal, and addressed the question of interpreting the definition of “wages” at Section 3121 of the Internal Revenue Code (IRC), which broadly defines wages as “all remuneration for employment,” with many specific exceptions that do not include severance pay.
The Sixth Circuit based its analysis primarily on the interpretation of IRC Section 3402(o), the heading of which reads “Certain Payment Other Than Wages,” and the body of which includes the following:
“For purposes of this chapter (and so much of subtitle F as relates to this chapter) – any supplemental employment benefit paid to an individual … shall be treated as if it were a payment of wages by an employer to an employee…”.
IRC Section 3402(o), however, addresses federal income tax withholding, and not FICA wages.
Notwithstanding that IRC Section 3402(o) is not a FICA provision, the Sixth Circuit took the position that the use of “as if” created the necessary implication that severance pay was not to be considered wages within the meaning of IRC Section 3121. In support of this interpretation, the Sixth Circuit cited the Supreme Court’s decision in Rowan Companies, Inc. v. U.S., 452 U.S. 247 (1981), which found that Congress intended the meaning of wages to be the same for FICA and federal income tax withholding purposes.
Based on these interpretations, the Sixth Circuit held in Quality Stores that severance pay is not subject to FICA taxes. This went against the holding in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), where the Federal Circuit held that severance pay should be considered wages under IRC Sec. 3121. The Sixth Circuit’s decision created a split, which immediately ushered in a large number of refund claims by business taxpayers, and not surprisingly, the Supreme Court granted certiorari to hear the decision.
The Supreme Court rejected the Sixth Circuit’s analysis, and found that neither the heading to IRC Sec. 3402(o) nor the “as if” language should change the broad reading of the term “wages” under IRC Sec. 3121. The Supreme Court noted that IRC Section 3121 had specific exclusions from wages for selected termination-related payments, implying that if Congress intended to exclude severance payments from wages it would have specifically addressed severance (just as it did the other termination-related payments).
The Supreme Court also looked at the legislative history behind IRC Sec. 3402(o), and found that the language was included to address a specific scenario – severance benefits that were tied to the receipt of state unemployment benefits. These so-called supplemental unemployment benefits needed to be considered as non-wages in order for laid-off workers to qualify for state unemployment benefits (even though they would be taxable). But varying constituents were concerned that a failure to withhold would cause problems for the laid-off workers, and Congress enacted IRC Sec. 3402(o) to provide the solution.
With this background, the Supreme Court found that IRC Sec. 3402(o) was designed to address a specific circumstance related to withholding, and was not at all designed to narrow the expansive definition of wages in IRC Sec. 3121. It reconciled its holding with the Court’s prior decision in Rowan by indicating that Rowan stood less for the idea that FICA wages and federal withholding must be the same, and more for the proposition that ease of administration and consistency in statutory interpretation should inform the definition of wages.
The Supreme Court’s decision in Quality Stores puts to rest any claim that severance pay is not to be considered wages for tax purposes.