July 25, 2014

Supreme Court Decides in Favor of IRS in Quality Stores: FICA (Federal Insurance Contributions Act) Generally Applies to Severance Payments

The Supreme Court of the United States has decided in favor of the Internal Revenue Service in United States v. Quality Stores, Inc., holding that severance payments made pursuant to plans that did not tie payments to the receipt of state unemployment insurance are subject to Federal Insurance Contributions Act (FICA) tax.  The decision overturns a taxpayer-friendly decision from the U.S Court of Appeals for the Sixth Circuit, which, if upheld, could have resulted in FICA tax refund claims to individuals and employers.

On March 25, 2014, in a somewhat surprising unanimous decision, the Supreme Court of the United States agreed with the Internal Revenue Service (IRS) that severance payments made pursuant to plans that did not tie payments to the receipt of state unemployment insurance are Federal Insurance Contributions Act (FICA) wages, overturning a decision from the U.S. Court of Appeals for the Sixth Circuit.  The decision lays to rest a long-time controversy about whether payments made pursuant to a plan for involuntary terminations are subject to FICA, and will prevent taxpayers from making successful FICA refund claims, as described in our February 13 publication.  By some estimates, FICA refunds to individuals and employers could have totaled more than $1 billion.


In 2001, Quality Stores, Inc. and its affiliates made severance payments to thousands of employees who were involuntarily terminated as part of Quality Stores’ Chapter 11 bankruptcy.  Quality Stores reported the payments as wages on Form W-2, paid the employer’s share of the required FICA taxes and withheld the employees’ share of FICA taxes.  Later, on its own behalf and on behalf of former employees, Quality Stores filed for a refund of $1,000,125 in FICA taxes.  The IRS neither allowed nor denied the claim.  However, when Quality Stores filed for bankruptcy, the bankruptcy court granted summary judgment in its favor.  The U.S. Court of Appeals for the Sixth Circuit affirmed, concluding that severance payments are not “wages” for FICA purposes.

The Sixth Circuit decision was in conflict with IRS Revenue Ruling 90-72, which provides that “supplementary unemployment benefit” payments (SUB payments) are FICA wages, unless they meet specific conditions, including that payments be specifically designed to supplement state unemployment benefits that the individual is qualified to receive.  The Sixth Circuit decision was also in conflict with CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), which held that payments like those made by Quality Stores are wages under FICA.

U.S. Supreme Court Decision

The Supreme Court concluded that Section 3121(a) of the Internal Revenue Code (the Code) defines FICA wages broadly as “all remuneration for employment,” and that service for employment purposes means “not only work actually done but the entire employer-employer relationship for which compensation is paid.”  This broad definition is reinforced by the specificity of FICA’s lengthy list of exemptions provided by statute.  Accordingly, the severance payments made by Quality Stores to former employees were wages for FICA purposes.

Quality Stores had argued that wages did not include severance payments in large part because Section 3402(o) of the Code provides that supplemental unemployment benefits be treated “as if” they were wages for income-tax withholding.  However, the Supreme Court rejected this argument and concluded that Section 3402(o) was not enacted to cover all severance payments, but was only in the statute to provide for federal income tax withholding on some payments that were not wages but were ultimately subject to federal income tax outside of the wage definition.

Implications for Employers

The Quality Stores decision affects all employers both within and outside of the Sixth Circuit.  For those employers that filed protective claims for FICA refunds on the basis of the Sixth Circuit’s decision, the Supreme Court’s decision makes it clear that refund claims will not be granted.  No action is necessary on the part of these employers.  In light of the Supreme Court’s decision, it is expected that the IRS will not allow those claims.  Employers should not necessarily expect to receive notices of claim disallowance.

The Quality Stores decision affirms the IRS position that severance payments made pursuant to plans that do not tie payments to the receipt of state unemployment insurance are FICA wages.  However, the IRS still takes the position that severance payments that are properly linked to the payment of state unemployment benefits and which are not paid in a lump sum remain exempt from FICA tax, as described in Revenue Ruling 90-72.

© 2014 McDermott Will & Emery

About the Author


Robin L. Greenhouse is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  Robin represents clients in resolving complex federal tax controversies with the IRS at audit or appeals, and in tax litigation in the U.S. Tax Court, the U.S. Court of Federal Claims and the U.S. District Courts.  She has litigated federal tax cases involving numerous issues, including:  foreign tax credits, allocation of expenses between domestic and foreign source income, section 1341 claim of right, calculation of interest,...


About the Author


Jeffrey M. Holdvogt is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office. 

Jeffrey focuses on matters related to employee benefits and executive compensation, including pension, profit sharing, 401(k), ESOPs, welfare and nonqualified deferred compensation plans.   Prior to joining McDermott, Jeffrey served as a law clerk for the Honorable Paul H. Anderson and James H. Gilbert of the Minnesota Supreme Court.

While in law school, he was an executive...

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Ruth Wimer, Esq., CPA, is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  She focuses her practice on matters related to executive compensation including international, fringe benefits, personal use of employer aircraft and qualified and non-qualified deferred compensation.

Ruth has extensive experience advising clients on structuring optimum ownership of business aircraft, factoring in deduction and income inclusion for personal use, excise tax, depreciation, ...


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