Paul L. Caron

Sunday, October 28, 2012

WSJ: When Severance Pay Is Subject to Payroll Tax

Wall Street Journal Tax Report:  When Severance Pay Is Subject to Payroll Tax, by Laura Saunders:

Do laid-off workers and their former employers owe Social Security and Medicare taxes on severance pay?

It is a huge question for taxpayers and companies, and two federal appeals courts disagree about the answer.

Here is what is at stake: Ordinarily employees and employers each owe a flat Social Security tax of 6.2% up to a cap (currently $110,100), plus Medicare tax of 1.45% (unlimited) on wages, for a combined rate as high as 15.3%. Together these are known as FICA, or payroll, taxes. For an executive who was laid off in early 2009 and received $100,000 of severance, for example, the total tax in question could come to about $15,000, split equally between the former worker and his firm.

In September, the Sixth Circuit, in United States v. Quality Stores, Inc., granted a bankrupt retailer a refund for FICA taxes paid on severance. In 2008, however, the Federal Circuit, in CSX Corp. v. United States, ruled that the railroad owed FICA taxes on severance payments it made to laid-off workers.

Experts say the issue could wind up before the U.S. Supreme Court unless the Sixth Circuit grants a rehearing of Quality Stores, requested by the U.S., and then reverses its September decision. The Sixth Circuit judges haven't ruled on the rehearing petition, which was filed earlier this month. The legal issue before the courts turns on whether severance pay (known as "supplemental unemployment benefits") is subject to these taxes. The answer involves legal intricacies, but independent tax analyst Robert Willens finds the arguments in Quality Stores, which sided with taxpayers, persuasive.

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