On March 25, 2014, the U.S. Supreme Court ruled 8-0 in United States v. Quality Stores, Inc. that severance payments made to involuntarily terminated employees are taxable “wages” subject to FICA taxes. This decision resolved a split among lower federal courts which left some employers uncertain whether to withhold and pay FICA taxes on severance payments.
As a result of the decision in Quality Stores, employers and employees now know that their severance payments will be subject to FICA taxes. In addition, severance payments – like all wage payments – will be subject to income tax withholdings.
Income tax withholdings on severance payments are usually a flat-rate 25% withholding. This is because the severance pay are considered “supplemental” wages rather than ordinary wages. However, if the employee receives supplemental wages exceeding $1,000,000, the income tax withholding increases to a flat-rate 39.6%.
For 2014, the total FICA tax is 2.9% for Medicare and 12.4% for Social Security. An additional 0.9% Medicare tax is added for individuals making over $200,000/year. The total FICA tax is paid equally by the employer and employee – with half being paid by the employee through automatic withholdings. The other half is paid by the employer as payroll tax.
The bottom line: severance payments just got more expensive for both employer and employee.
You can find the Supreme Court’s opinion in Quality Stores here.
