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Whether Severance Payments are Subject to FICA Tax

An employer who made severance payments to terminated employees, or terminated employees, who received severance payments, should consider timely filing a claim for refund if FICA taxes were withheld and paid by the employer.

The Internal Revenue Service has no dispute with respect to severance payments under a plan that is conditioned on a terminated employee's eligibility for or receipt of state unemployment benefits. (See IRS Revenue Ruling 90-72.) Such plan is considered a supplemental unemployment benefit (SUB) plan and benefits paid under such plan are specifically excluded from being considered "wages" subject to taxes imposed under the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA).

However, a recent district court decision, U. S. Quality Stores, Inc., et al., 2/23/10, concludes further. In affirming a bankruptcy court decision, it concludes that any payment to an employee pursuant to a plan under which payments are made to an employee because of the employee's involuntary separation from employment (whether or not temporary) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions are "supplemental unemployment compensation benefits" (if includible in gross income for purposes of the income tax) excludable from being considered "wages" subject to FICA or FUTA tax.

Recommended Action:

While it is understood that this judgment will be appealed, we can file protective refund claims for FICA taxes paid on account of severance pay. While no refunds will be issued until the appeals process is exhausted, the protective claims will prevent the statutes from expiring. Please note that the refund claim would include only the employer's share of the FICA and Medicare taxes. This protective claim should be filed on a Form 941X.

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