Yesterday the Supreme Court of the United States heard oral arguments in United States v. Quality Stores, Inc., a case on appeal from the Sixth Circuit Court of Appeals. A circuit court split had spurred the Court to hear the case to decide whether certain severance payments made to employees whose employment is involuntarily terminated are taxable under the Federal Insurance Contributions Act (FICA).
The government, arguing that the severance payments at issue in the case are wages under FICA because the payments were remuneration for employment, attempted to explain away the impact of section 3402(o) of the Internal Revenue Code on the definition of wages. The respondent argued that section 3402(o), which governs supplemental unemployment compensation benefits, should be interpreted to exempt the payments at issue from FICA taxes. According to the government, and contrary to the respondent’s view, Congress did not enact section 3402(o) to alter the definition of wages for FICA purposes.
Justice Ginsburg questioned the government about the impact of its position on state unemployment compensation payments. Justice Alito pressed the government on whether its argument would be different if the severance payments were not connected to employees’ length of service and salary—to which the government responded that the payments would still be considered wages as “keyed to the critical aspects of the employment relationship.”
The respondents in the case, relying heavily on section 3402(o)’s heading, “Extension of Withholding to Certain Payments Other Than Wages” (emphasis added) and the statute’s text, which provides that a supplemental unemployment compensation benefit “shall be treated as if it were a payment of wages,” argued that severance payments that satisfy the definition of supplemental unemployment compensation benefits set forth in section 3402(o) should not be considered wages under FICA. At this point, the justices—particularly Justices Breyer, Alito, and Scalia—questioned the congressional purpose behind passing section 3402(o). In particular, Justice Scalia—acknowledging the respondent’s use of “the principle that you should interpret a statute to make sense and not interpret any provision to be superfluous”—pressed the issue of whether the government’s interpretation renders section 3402(o) unnecessary. The government’s response, in part, was that the Court need not even rely on section 3402(o) to resolve the case because the case could be very easily resolved by looking at the FICA statute alone.
If the Supreme Court upholds the Sixth Circuit’s ruling that supplemental unemployment compensation benefits within the meaning of section 3402(o) are not wages for FICA tax purposes, the Internal Revenue Service (IRS) could owe more than $1 billion in FICA tax refund claims to individuals and employers that have filed protective refund claims pending the outcome of the Quality Stores case. The outcome of the Quality Stores decision will shape the FICA tax implications of supplemental unemployment compensation benefits and may influence whether employers continue to provide one of the following types of termination benefits:
(1) supplemental unemployment compensation benefits that are linked to the receipt of state unemployment benefits which, pursuant to the IRS’s administrative position (in revenue rulings and private letter rulings) going back to the 1950s, is not subject to FICA or Federal Unemployment Tax Act (FUTA) taxes;
(2) supplemental unemployment compensation benefits within the meaning of section 3402(o) (at issue in the Quality Stores case); or
(3) traditional severance.
We will report on the Supreme Court’s ultimate decision in the case upon its issuance. More information about the IRS’s administrative position (which is not directly at issue in Quality Stores) that supplemental unemployment compensation benefits linked to the receipt of state unemployment benefits are FICA tax exempt is available in part one of a two-part blog series, “The Advantages of Offering Supplemental Unemployment Benefits Instead of Severance, Part I: FICA Taxes and More.”
Vicki M. Nielsen is of counsel in the Washington, D.C. office of Ogletree Deakins.
Hera S. Arsen, J.D., Ph.D. is managing editor of firm publications in the Torrance, California office of Ogletree Deakins.