Severance payment tax treatment to get Supreme Court review

The U.S. Supreme Court has agreed to hear the government’s argument that severance payments made to employees when their bankrupt employer shut down are taxable under the Federal Insurance Contributions Act.

The case presents an apparent split between two federal courts of appeals, with the 6th Circuit ruling last year that severance payments to involuntarily terminated employees are not wages for FICA purposes.  In re Quality Stores Inc. et al., 693 F.3d 605 (6th Cir. 2012).

(Westlaw users: Click here for more stories from Westlaw Journal Bankruptcy.)

A federal appeals panel in Washington, D.C., reached a different conclusion four years before in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

Severance payments

Quality Store Inc. filed an involuntary Chapter 11 proceeding in 2001 in the U.S. Bankruptcy Court for the Western District of Michigan.

The company eventually folded, closing more than 300 stores, and made severance payments to employees who had been involuntarily terminated, according to court records.  It reported the payments as wages and withheld federal income tax and FICA tax.

Quality Stores later requested that the Internal Revenue Service refund $1 million in FICA taxes.

When the agency declined, the company and some former employees filed an adversary action in the Bankruptcy Court in 2005.  They claimed the payments were not wages, but instead constituted supplemental unemployment compensation, or SUB, benefits that are not taxable under FICA, 26 U.S.C. § 3402.

The Bankruptcy Court agreed in a 2008 decision, and ordered a full refund.

After the District Court affirmed two years later, the government appealed to the 6th Circuit.

The appeals court said its reading of the Internal Revenue Code led to the conclusion that the severance payments have not been legislatively defined as “wages” for purposes of FICA taxation.

The 6th acknowledged the Federal Circuit’s contrary decision in CSX Corp., but disagreed with what it called that court’s use of the IRS’ administrative definition of SUB payments rather than the congressional definition of wages in the Internal Revenue Code.

Supreme Court petition

The Justice Department turned to the Supreme Court, arguing in a petition for certiorari that the severance payments “fit comfortably” within FICA’s broad definition of wages.  It asked the high court to adopt the Federal Circuit’s holding in CSX Corp.

Quality Stores countered that the 6th Circuit correctly found that Congress has excluded SUB payments from the definition of wages.

The Supreme Court agreed Oct. 1 to hear the case.

Resolution of the issue by the high court may have far-reaching effects, according to the government.

The Justice Department says in court papers that the proper tax treatment of severance payments under FICA is of exceptional importance, with more than $1 billion in administrative refund claims pending in nearly a dozen cases.

(Click here for the government’s reply brief on Westlaw.)

United States v. Quality Stores Inc., No. 12-1408, cert petition granted (U.S. Oct. 1, 2013).