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American Payroll Association (APA) Basic Guide to Payroll, 2013 Edition

American Payroll Association (APA) Basic Guide to Payroll, 2013 Edition
It's more important than ever to be in compliance with payroll laws and regulations! How do you stay in compliance and avoid penalties? The APA Basic Guide to Payroll is written to make understanding the laws and regulations as easy as possible. And this single-volume guide is filled with tools to help you apply the law and make proper calculations – with ease!

CCH® PAYROLL — 04/22/10

Severance pay not subject to FICA taxes, rules federal court

In a taxpayer-friendly decision, a federal court has found that severance payments are not “wages” for FICA (Social Security) purposes. The decision of the US District Court for the District of Michigan, Western Division, is certain to have significant ramifications in today's economy for both employers and employees terminated from employment. The payments were supplemental unemployment compensation benefit (SUB) payments under Code Sec. 3402(o)(2), and “the clear import of Code Sec. 3402(o)(2)” is that any payments meeting the definition of supplemental unemployment compensation benefits in Code Sec. 3402(o)(2) are not considered wages.

The FICA tax treatment of severance pay has been a controversial issue over the past several years, and is likely to continue as a highly litigated one considering the pro-taxpayer opinion in this case and the terminations made as a result of the economic downturn.


The taxpayer made severance payments to employees terminated as a result of workforce reductions and facility closings. The payments were included as wages on employees' W-2 forms. The taxpayer withheld federal income tax and the employees' share of FICA tax, and paid its share of FICA tax. The taxpayer later filed refund claims for overpaid FICA on the severance payments.

Definitions of “wages”

Generally, IRC 3401(a) defines “wages” subject to income tax withholding in the same manner as Code Sec. 3121(a) defines “wages” for FICA purposes. Code Sec. 3402(o)(2) imposes income tax withholding on SUB pay as if they were wages. Code Sec. 3121(a) does not specifically exclude SUB pay from wages. SUB pay is defined under Code Sec. 3402(o)(2).

Severance payments not remuneration for wages

According to the district court, the severance payments under review should be viewed as wage-replacement social benefits, not as remuneration for wages. Thus, they are not subject to FICA tax. Rejecting the government's argument, the court concluded that there is “no basis for concluding that Code Sec. 3402(o)(2) does not control the determination whether the severance payments” were taxable for FICA purposes.

The court addressed the Supreme Court's decision in Rowan Companies, Inc. v. USA, which declared that Congress intended a uniform definition of “wages” for purposes of FICA, FUTA and income tax withholding. After this decision, Congress amended Code Sec. 3121(a) to decouple the definitions of wages under the withholding provisions. However, since the IRS has not issued any regulations to distinguish between the wage exclusions, Rowan remains controlling. Note that IRS revenue rulings are not a substitute for regulations. (Quality Stores, Inc. v. US, 2010-1, USTC 50,250, W.D. Michigan, Feb. 23, 2010.)

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