Are Severance Payments Subject to FICA?

According to the recent decision in United States v. Quality Stores,

Inc., No. 1:09-cv-44 (W.D. Mich. Feb. 23, 2010) (“Quality Stores”),

severance payments resulting from an involuntary termination are not

subject to taxation under the Federal Insurance Contributions Act

(“FICA”) because such payments do not constitute “wages.” Prior to

Quality Stores, it was generally accepted that severance payments are

taxed like any other bonuses.

While it is generally accepted that severance payments are a form of

“wages” subject to FICA, it is unclear whether the “social benefit” type

analysis found in Quality Foods will catch on in other jurisdictions.

In the future, a well advised employer will continue to withhold and pay

FICA taxes on severance payments, and a well advised employee may use

Quality Stores to seek to avoid FICA withholding on severance.

Separation agreements are often negotiated, and the issue of tax

withholding is often subject to contentious disagreement between

employer and former employee. An employee will often argue that he or

she is being paid for something that is non-taxable or not subject to

withholding, while an employer will want to take the most conservative

approach, since they have the withholding obligation.This is a question

of law – not a business term – so the lawyers can argue ad nauseum about

it.The Quality Stores opinion gives us one more thing to disagree

about.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City. Read My Full Bio

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