Severance Payments Are Taxable “Wages”

severanceThe US Supreme Court ruled yesterday that an employer’s severance payment to employees were “wages” under the Federal Insurance Contributions Act (FICA) and should have been taxed by the employer as such. The severance was paid to employees who were involuntarily terminated as part of the company’s bankruptcy. The bankruptcy court, the district court and federal appeals court all ruled that the payments were not wages for purposes of FICA. The Supreme Court disagreed. The Court relied upon the extremely broad definition of “wages” under FICA: “the term ‘wages’ means all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except . . .” 26 U.S.C. § 3121(a). This broad definition is followed by a lengthy and detailed list of exceptions. The Court reasoned that the broad definition coupled with the specific list of exceptions leads to the conclusion that Congress intended all forms of remuneration not on the list of exceptions to be taxed as a wage. In the great majority of cases, payments in the form of severance, regardless of the label, should be treated as replacement wages and taxed accordingly. The same is true of payments to settle wage claims. Payments related to claims of wrongful termination, discrimination or harassment, however, may not be taxable under FICA. To the extent the payment is for lost wages, the payment should be taxed under FICA. To the extent the payment is for emotional distress, the payment is not taxable under FICA. The payment is taxable income to the recipient employee, but does not require the employer to withhold and pay payroll taxes. Employers should be cautious any time payments are made to employees or former employees and not treated as taxable wages. Payments should be carefully analyzed and then supported by specific written agreements or policies which clearly delineate the nature of the payment and its taxable character. The Courts opinion can be found at: http://www.supremecourt.gov/opinions/13pdf/12-1408_6468.pdf