Tag Archives: severance

Supreme Court Holds that Severance Payments for Departing Employees are Subject to Payroll Taxes

Contributed by Sara Zorich

On March 25, 2014, the Supreme Court in United States v. Quality Stores, U.S., No. 12-1408, 2014 WL 11168968, 3/25/14) overturned the Sixth Circuit and unanimously held severance payments made to terminated workers were subject to payroll taxes including the Federal Insurance Contributions because the payments constituted “wages” and were in connection to services employees provided to the employer.

The defendant, Quality Stores, had made severance payments to employees who were voluntarily terminated prior to a Chapter 11 bankruptcy.  Quality Stores paid and withheld taxes subject to the Federal Insurance Contributions Act (FICA) but later believed the payments should not have been taxed and sought a refund from the U.S. government on behalf of itself and the 1,850 employees for which payments and withholdings had been made.  The Sixth Circuit held that the severance payments were not wages under FICA and thus, Quality Stores and the employees were not responsible for FICA taxes.

The U.S. Supreme Court reviewed the matter and overturned the Sixth Circuit’s decision.  The High Court held that that term “wages” is interpreted very broadly under FICA.  The Court determined the severance payments were being paid for the employee’s “service” which is not only the work actually done but constitutes the entire employer-employee relationship.  Thus, under FICA’s broad definition of wages, Quality Stores’ severance agreements were taxable as wages under FICA.  The Court recognized there is an exemption to taxable wages for certain severance plans that are tied to the receipt of state unemployment benefits.  However, the Court found that the severance plans at issue varied based on employee seniority and time served, and were not linked to the receipt of state unemployment benefits so they were taxable wages.  It should be noted that the Court addressed the distinction for severance payments and plans that are tied to the receipt of state unemployment benefits which are exempt from income-tax withholding and FICA taxation, and made no comment on such plans since they were not at issue in this matter.

Based on this ruling, employers must be careful when drafting severance agreements and understand that the definition of such wages will be interpreted broadly when determining whether such wages are taxable under the law.

To Pay or Not to Pay…That is the Question

Contributed by Julie Proscia

When terminating an employee, particularly a long term employee, one of the first questions that an employer asks is: “Am I required to pay severance?” Which is quickly followed up by: “If so, how much should I pay?”

First, regardless of what you heard (from your friend Bob who heard from his cousin, who heard from her sister) there is no requirement in the State of Illinois, or on the federal level, that employers must give employees severance when conducting a lay off or termination.  Individuals frequently confuse severance pay with the requirement to pay out PTO/vacation. PTO/vacation time, if earned and accrued, must be paid with final wages at the next regularly scheduled pay period following separation. There is no requirement to pay severance. The two (final wages and severance) are different; one is payment for monies already earned and accrued while the other is money that has not been earned.

Think of severance as free money that you are giving to buy peace of mind (i.e. release agreement and/or reward for service).  The only time that you are required to give severance pay is if you have an internal policy, collective bargaining agreement or employment agreement that designates the same. In the absence of an internal document requiring the payment of severance it is a company’s sole discretion as to whether or not it wants to give severance.

Likewise, if an employer chooses to give severance there is no designated amount that it is required to give. I frequently hear employers ask if they are required to give one week for every year of service. There is no requirement to do so. This was often the case in high level executive separations in the boom time of the eighties but quickly dissipated with the bust of the 2000s.

In the new era of mass layoffs severance is often impractical (it is hard to lay off 100 people because of budgetary constraints and then pay them each severance) and is thus irregular for large separations.  In these cases, severance, if given, is done more to assist the employee with COBRA payments or to continue an employee’s salary to the end of the month.  On an individual basis severance is frequently only given to be consistent with past practices or to prevent a “risky” separation from turning litigious (i.e. to the only employee in the group who is over 40 and who also recently filed a harassment complaint, not the 25 year-old Caucasian male). The analysis of whether or not you should give an employee severance is one that should be done with your labor and employment counsel to determine the legal risks of the separation and the cost-benefits to the package.

So then the question becomes whether to pay or not to pay. Just remember, if you choose to pay make sure that the package includes a release agreement.  The release agreement is imperative; there is nothing that irritates a company more than when it gives an employee $10,000 in severance and the employee gives that money to an attorney for a retainer for his wrongful termination lawsuit….