June 2010
When
Wages are NOT FICA Wages
Recently a
U.S. District Court in Michigan affirmed the decision of the
Bankruptcy Court that certain severance payments were not
taxable for purposes of FICA taxation. The ruling
found that the payments fell within the
exception of the Internal Revenue Code associated with supplemental unemployment
compensation benefits.
The
plaintiff in the case operated a chain of retail stores. It
went bankrupt and was forced to close its stores. After
some time all its employees were terminated and severance
payments were made to employees who were terminated. The
severance payments were included in the employees’ gross
income and reported as wages on the W-2 forms issued to
employees. Federal income tax and the employees’ share of
FICA tax were withheld. The plaintiff also paid the
employer’s share of FICA tax with respect to the severance
payments. Within the following year the plaintiff filed
refund claims with the IRS seeking to recover over a million
dollars in allegedly overpaid FICA taxes.
In
general, the Code states that any supplemental
unemployment compensation benefit paid to an
individual shall be treated as if it were a payment of wages
by an employer to an employee for a payroll period. The
Code defines supplemental unemployment compensation
benefits to mean amounts which are paid to an
employee, pursuant to a plan to which the employer is a
party, because of an employee’s involuntary separation from
employment (whether or not such separation is temporary),
resulting directly from a reduction in force, the
discontinuance of a plant or operation, or other similar
conditions, but only to the extent such benefits are
includible in the employee's gross income.
The
court’s ruling cites various conflicting views and describes
the issue as a “legally-confounding question.” However, in
the final analysis it was persuaded that the severance
payments were “wage-replacement social benefits” and NOT
“taxable remuneration for the employees’ services or
wages.” Consequently, the court determined the severance
payments were not subject to taxation for FICA purposes.
The ruling
conflicts with IRS' Employer’s
Tax Guide wherein it specifically indicates that severance
pay is taxable for FICA purposes. In addition, there seems
to be a number of other IRS rulings and the like that
indicate that severance pay is indeed FICA taxable. Thus,
we urge you to seek the advice of a qualified advisor if you
are concerned about your particular situation.
Questions
may be directed to Vincent Ruocco, LLC, CPA at 203.932.2931
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