A federal appeals court ruled last week that certain severance payments are not subject to FICA taxes, which opens the door for employers and laid-off employees to apply for a refund on FICA taxes they previously paid on severance packages.

FICA Tax Refund

The Sixth Circuit Court of Appeals – which covers Ohio, Kentucky, Tennessee and Michigan – ruled that severance payments are supplemental unemployment benefits if they meet a five-point definition, and as such they are not subject to FICA taxes.

Because this issue is likely to generate further discussion in the courts – and perhaps in Congress – Barnes Dennig encourages its clients to continue withholding and paying FICA taxes on severance payments, then apply for a refund.

In the case of United States vs. Quality Stores, Inc., the Sixth Circuit Court ruled that a severance payment qualifies as a “supplemental unemployment benefit” (and not “wages” as defined for FICA) if it meets the following criteria:

(1) an amount paid to an employee; (2) pursuant to an employer’s plan; (3) because of an employee’s involuntary separation from employment, whether temporary or permanent; (4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee’s gross income.

The Sixth Circuit Court upheld the 2010 decision of a U.S. district court in Michigan, which ruled that Quality Stores was due a refund from the IRS on the FICA taxes it paid on severance packages. Those rulings contradict a 2008 decision in a different Federal court. Given the conflicting rulings, it is likely that the courts and/or Congress will debate the issue further.

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