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Layoffs and taxes: Supreme Court to rule on severance payments

In recent years, layoffs have become a frequent and seemingly permanent part of the national economic landscape. Even with the Great Recession officially over for more than four years, there are still plenty of people losing their jobs.

Many of these people get severance pay. And so the tax treatment of severance payments is a timely issue both in Texas and across the country.

Last week, the U.S. Supreme Court announced it would hear a case involving the applicability of Social Security taxes to severance income. In this post, we’ll summarize what that case is about.

The case is called United States v. Quality Stores, Inc. The specific issue is whether severance payments are subject to Social Security taxes when the termination of employment was involuntary.

In other words, the case concerns severance payments following layoffs imposed by the employer, not severance payments negotiated by an employee in a voluntary departure from an employer.

On paychecks, Social Security taxes are often referred to as FICA. That is because FICA refers to the Federal Insurance Contributions Act, which is the authorizing legislation for Social Security taxes. Payroll taxes imposed under FICA also help finance Medicare.

These taxes are also sometimes called employment taxes.

The Obama administration contends that severance payments are “wages” under FICA. And, according to the administration’s reasoning, the payments are therefore subject to tax.

Quality Stores argues, however, that the severance payments it made to employees should be categorized not as wages but as a form of additional unemployment compensation.

Lower federal courts have reached conflicting decisions on the issue. That is surely one of the reasons why the Supreme Court agreed to hear the Quality Stores case.

Source: Bloomberg, "Taxes on Severance Payments Draw U.S. High Court Review," Greg Stohr, Oct. 1, 2013

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