The U.S. Supreme Court has unanimously held that payments of supplemental unemployment benefits (SUB payments) are taxable wages subject to FICA tax withholding. The Court’s decision in United States v. Quality Stores, Inc., issued on March 25, 2014, represents a significant victory for the Internal Revenue Service (IRS) and closes the door on many refund claims filed by employers and employees to recover remitted FICA taxes.

Under the Internal Revenue Code (the Code), a SUB payment is any payment that is (i) paid to an employee, (ii) paid pursuant to an employer plan, (iii) paid as the result of an employee’s involuntary separation from employment, (iv) paid as a result of a reduction in force, the discontinuance of a plant or operation, or other similar conditions, and (v) includible in the employee’s gross income.

FICA taxes must be withheld from “wages” paid to employees for services performed, while federal income tax must be withheld from wages and certain other payments to employees. The FICA tax law defines “wages” as “all remuneration for employment” for both income tax withholding and FICA tax withholding. A specific Code provision further provides that, for federal income tax withholding purposes, SUB payments are treated “as if” they are wages. The “as if” language led many taxpayers to argue that, although federal income tax withholding was required from SUB payments, FICA tax withholding was not required because the SUB payments are not actually wages, just treated as wages for income tax withholding.

Notwithstanding this ambiguity, the IRS has long asserted SUB payments are wages for FICA purposes unless such payments are specifically designed to supplement state unemployment benefits. In CSX Corp. v. United States, the Federal Circuit agreed in 2008 with the IRS’s position and held that SUB payments are subject to FICA taxes. Four years later, however, the Sixth Circuit’s Quality Stores decision holding that SUB payments are not wages for FICA taxes presented taxpayers with billions of dollars in refund opportunities.

In Quality Stores, the taxpayer sought a refund of FICA taxes remitted with respect to payments to terminated employees that were not connected to any state unemployment compensation and were not attributable to any specific service performed by the employees. The Sixth Circuit held that, under the Code, the SUB payments were not wages for FICA purposes; instead, it held that the Code provides that SUB payments are non-wage payments treated “as if” they are wage payments only for the purposes of federal income tax withholding. Therefore, the Sixth Circuit held that SUB payments were not subject to FICA tax withholding. (See our alert dated October 11, 2012.)

The Supreme Court unanimously resolved the dispute between the Federal and the Sixth Circuits by agreeing with the IRS’s long-held position. The Court first held, because the term “wages” for FICA taxes includes “all remuneration for employment,” it must include payments for “not only work actually done but the entire employer-employee relationship for which compensation is paid.” Consequently, the Court held that severance payments are payments of wages for FICA tax purposes.

The Court further held that, although the Code treats SUB payments “as if” they are wages for federal income tax purposes, the “as if” language does not mean that severance payments are not wages for other purposes. When this language was added, many states provided unemployment benefits to terminated employees only if the terminated employees were not earning wages at the time. Because such payments are subject to federal income tax, if the unemployment benefits were not subject to withholding at the time of payment, the terminated employees could have faced large tax bills at the end of the year. Congress sought to mitigate that risk by treating SUB payments “as if” such payments were wages, thereby requiring federal income tax withholding.

The Court determined that the “as if” language merely solved the income tax withholding problem but did not address whether SUB payments were wages for FICA tax purposes. Because the Court determined that all severance pay is remuneration for employment, it held that SUB payments are wage payments for FICA tax purposes.

After Quality Stores, employers should withhold federal income tax, FICA tax (along with contributing the employer portion), and relevant state and local taxes from severance pay, including SUB payments, unless the SUB payments specifically supplement state unemployment benefits. Employers and employees who filed refund claims based on the Sixth Circuit’s decision do not need to take any action, but the IRS will deny their claims.

For questions about Quality Stores or other employment issues, including employment tax issues, please contact Wendi L. Kotzen at 215.864.8305 or, Timothy F. McCormack at 410.528.5680 or, or another member of Ballard Spahr's Tax or Labor and Employment Groups.

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