Do I Have to Pay Social Security Tax on Severance Pay?

If downsizing, a business closing or the economy places you in the ranks of the unemployed, your employer may provide severance pay. Some employers generously assist the employee for several months, and some base severance pay on the years of employment with the company. Employers withhold Federal Insurance Contributions Act taxes from severance pay to cover Social Security and Medicare. The employers submit and match this amount as required by law. The Internal Revenue Service has only one obvious exemption to this requirement.

IRS Revenue Ruling 90-72

Internal Revenue Service revenue ruling 90-72 establishes that a plan devised to supplement the state unemployment benefits is exempt from FICA taxes. The IRS refers to this as an SUB plan for supplemental unemployment benefits. If your employer sets up a SUB plan or pays your severance pay over a period of months, you may not have to pay FICA taxes on your benefits. Two federal court cases have attempted to define severance pay included or excluded from FICA taxes, and it appears that the U.S. Supreme Court will eventually write the definitive opinion.

Conflicting Decisions

CSX Corporation vs. United States, 518 F.3d 1328 (2008), held that severance pay is subject to FICA taxes. United States of America vs. Quality Stores, Inc., Case No. 1:09-cv-44 in the U.S. District Court for the Western District of Michigan (2010), held that severance pay was not wages, and that the funds were supplemental unemployment benefits under IRS 90-72. In July 2010 the government filed a brief in the Quality Stores case and the reply brief was due in September, 2010. This case may provide a definitive answer when it makes its way through the court system.

Advantages

FICA taxes apply to "wages" under 26 U.S.Code 3121 of the Internal Revenue Code. You may want the 6.2 percent you paid into Social Security and Medicare in 2010 or the 4.2 percent paid in for 2011 when you are unemployed. However, this tax adds to your Social Security credits for your retirement. If you need the credits to make your 10 years of work history, the withholding is important to you.

Current Trends

Withholding Social Security and Medicare taxes from your severance pay is the most common, safest approach to an unresolved tax issue. The employer does not want an assessment from the IRS to cover the taxes for both employee and employer. Unless the employer sets up an SUB plan in accordance with the revenue ruling, there is no present alternative to withholding FICA taxes on severance benefits. The CSX case applied Social Security and Medicare taxes to severance pay, and your former employer will likely do the same. Some employers are filing protective refund claims awaiting the outcome of the case law.

References

• Society for Human Resource Management: Be Cautious of Ruling that Severance Pay Isn't Subject to FICA; William Hays Weissman; April 2010
• Appellate Tax: U.S. Opening Brief Filed in Quality Stores; Alan Horowitz; July 2010
• IRS.gov: Social Security Tax / Medicare Tax and Self-Employment; November 2010
• Cornell University School of Law: Legal Information Institute: 26 U.S. Code 3102
• Cornell University School of Law: Legal Information Institute: 26 U.S. Code 3121

Resources

• IRS.gov: Publication 17: Wages, Salaries, and Other Earnings