US Supreme Court hears severance pay case

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Is a severance package a form of employment income, or does it constitute a supplemental unemployment benefit?

The answer makes a big difference when it comes to income taxes, and it’s now up to the justices of the U.S. Supreme Court to provide a definitive answer.

The court heard argument Tuesday in U.S. v. Quality Stores Inc., which stems from a 6th U.S. Circuit Court of Appeals ruling that severance payments received by employees of a company that ceased operation and went into bankruptcy were not taxable as income.

The company had reported the payments as wages on the employees’ W-2 forms and withheld federal income tax.

The employees later sought refunds from the IRS, arguing that the severance pay constituted supplemental unemployment benefit payments, and was therefore exempted from income taxes.

The 6th Circuit agreed, and the federal government successfully petitioned the Supreme Court for review.

Eric Feigin, assistant to the U.S. solicitor general, argued that severance pay falls within the definition of “wages” under the Federal Insurance Contributions Act and urged the court to interpret the definition “broadly to encompass the entire employer-employee relationship.”

Justice Samuel Alito Jr. asked if the result would be different if the payments were not linked to employment terms.

“What if the payments were not keyed to the length of service and to salary?” Alito asked. “[What if] it was just a flat severance payment?”

“We still think that would meet the basic definition of ‘wages’ under FICA,” Feigin said.

Robert Hertzberg, a partner in the Detroit office of Pepper Hamilton LLP arguing on behalf of the employees, pointed out that the government concedes that at least some forms of severance packages fall outside of FICA’s reach.

“Where the dispute lies is what SUB payments are covered by FICA and which are not,” Hertzberg said. “If the payments meet the definition of SUB payment under the statute, then they are not wages and not subject to FICA.”

Justice Ruth Bader Ginsburg pointed out the other side of the employees’ argument.

“There are some severance payments that do count for FICA purposes, isn’t that so?”

“‘Severance’ is a generic term, but payments such as dismissal payments, are treated as wages for FICA purposes,” Hertzberg said. “We believe the definition is different for supplemental unemployment benefits.”

A decision is expected later this term. Follow @DCDicta