United States Court of Appeals Split on FICA Taxes Resolved

May 19, 2014

On October 2, 2012, we alerted you to the Circuit Court split and potential refund opportunity for payroll taxes paid for severance payments. Over one year later, the Supreme Court of the United States has resolved the Circuit Court split in favor of the Internal Revenue Service (the “Service”). The Service has historically taken the position that severance payments are subject to payroll taxes. The Service’s position was supported by a 2008 decision from the United States Court of Appeals for the Federal Circuit in CSX Corp. v. United States (518 F.3d 1328). However, the United States Court of Appeals for the Sixth Circuit created the Circuit Court split when it affirmed a district court decision in U.S. v. Quality Stores, Inc. (No. 10-1563), adverse to the Service, holding that severance payments made to employees upon terminating their employment involuntarily because of business cessation, were not subject to Federal Insurance Contributions Act (FICA) taxes. The contrary decisions in CSX Corp. and Quality Stores created an irreconcilable split in authorities.

The United States Supreme Court Decision

On March 25, 2014, the Supreme Court of the United States ruled 8-0 in favor of the government in the Quality Stores litigation. The Court’s opinion closely tracks the government’s arguments made in its brief, holding that severance payments are taxable FICA wages subject to income tax withholding under Code section 3402(o), regardless of whether they fall within the category of “supplemental unemployment compensation benefits.”

Based upon our prior coverage, you may recall that Quality Stores, Inc. was seeking a refund of more than $1 million in FICA taxes it paid with regard to severance payments. As evidenced by the Circuit Court split on this issue, determining whether supplemental unemployment compensation benefits payments constitute “wages” under FICA is complicated. Neither the FICA statute nor the Treasury Department regulations address the specific issue. Quality Stores, Inc. received favorable opinions in both the bankruptcy court and the district court stating that the payments were not subject to tax (40 DTR K-1, 3/3/10). The Sixth Circuit determined that the severance payments at issue qualified as supplemental unemployment compensation benefits under Code Sec. 3402(o), which treats certain nonwage payments as if they were wages for income tax withholding purposes.

In its analysis, the Supreme Court addressed to the taxpayer’s argument that section 3402(o) directs that income tax should be withheld from supplemental unemployment compensation benefit payments “as if” they were wages, which indicates that they are not in fact “wages.” The Supreme Court found this provision is consistent in that “at least some severance payments are wages,” citing the Federal Circuit Court of Appeals decision in the CSX case.

The Court used another of the taxpayer’s arguments as support for its conclusion in favor of the government - i.e., that the 1981 decision in Rowan, supported the government’s position because the government’s argument best supported “the major principle recognized in Rowan: that simplicity of administration and consistency of statutory interpretation instruct that the meaning of ‘wages’ should be in general the same for income-tax withholding and for FICA calculations.”

Revenue Ruling Validity Not Addressed

The Supreme Court would not address the validity of the Service’s revenue rulings that exempt severance payments that are tied to the receipt of state unemployment benefits from (i) income-tax withholding and (ii) FICA taxation. Those revenue rulings are generous to taxpayers in comparison to what is otherwise a broad statutory requirement under the FICA definition. At oral argument, the Supreme Court questioned the government about these revenue rulings because they contradict the broad reading of the FICA “wages” definition argued by the government. The Supreme Court neither criticized nor overturned the revenue rulings; therefore, it remains possible that the Service will let those rulings stand.


The Sixth Circuit Court of Appeals decision in Quality Stores led many taxpayers in the Sixth Circuit to file protective claims for refunds for FICA taxes paid on severance payments. The Supreme Court’s recent decision, in resolving the conflict between the circuits, has generally invalidated these claims and eliminated the opportunity for companies to recover FICA taxes paid on their severance payments.

Dykema’s Taxation Practice Group members are available to assist taxpayers in a broad array of tax matters, including analyzing opportunities for refund claim filings. Please contact Anthony Ilardi at 248-203-0863 or Bill Lentine at 313-568-5371, with questions about the impact of Quality Stores, or about other tax matters. 

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