United States v. Quality Stores, Inc.
The Court ruled that severance payments made to employees who are laid off against their will count as taxable wages under the federal payroll tax law known as FICA, reversing a ruling that had let a bankrupt retailer avoid those taxes.
The decision resolves a split among federal appeals courts and means employers nationwide must keep withholding and paying Social Security and Medicare taxes on most severance payments, foreclosing a strategy some companies used to seek refunds.
“It would be contrary to common usage to describe as a severance payment remuneration provided to someone who has not worked for the employer.”
Explaining why severance pay counts as compensation tied to employment under FICA.
How it got here: The Bankruptcy Court, District Court, and Sixth Circuit all ruled for Quality Stores; the federal government asked the Supreme Court to resolve a split with other circuits.
The Case in Depth
What happened
A retail chain, Quality Stores, laid off thousands of employees during its bankruptcy and paid them severance based on job seniority and length of service. The company paid FICA payroll taxes on those payments but later argued the payments should not have counted as taxable wages, and sought a refund of about $1 million on behalf of itself and roughly 1,850 former employees.
The question before the Court
When a company lays off workers and pays them severance, does that money count as taxable wages under the Social Security and Medicare payroll tax law?
Why it matters
Businesses that pay severance to laid-off workers must keep withholding FICA taxes on those payments, and companies that had filed for refunds — including in other bankruptcy cases — lose that avenue. The ruling also protects the funding stream for Social Security and Medicare that depends on these payroll taxes being collected consistently nationwide.
What changes now
The case goes back to the lower courts, but the legal question is fully resolved: severance payments not tied to state unemployment benefits are taxable wages under FICA. Employers nationwide must continue withholding and paying FICA taxes on most severance pay, and Quality Stores' refund claim on behalf of itself and former employees fails.
What this does not decide
The Court expressly did not decide whether severance payments that are tied to the receipt of state unemployment benefits — which the IRS currently treats as exempt from FICA — are correctly exempt, since the payments in this case were not linked to state benefits.
How the Court got there
The legal reasoning, step by step
- The Court began with FICA's own definition, which taxes 'all remuneration for employment' and defines employment as any service performed by an employee for an employer — a deliberately broad definition.
- Applying plain meaning, the Court reasoned that severance payments are remuneration paid only to employees and only because of the employment relationship, so they naturally fit the statute's broad wording, especially since the amounts varied by job seniority and years served.
- The Court found support in the statute's structure: FICA lists a long, specific set of exemptions, including one for severance paid because of retirement for disability, and that exemption would serve no purpose if severance pay were not already treated as wages in general.
- Turning to the company's main argument, the Court examined a separate income-tax withholding provision, Section 3402(o), which says certain supplemental unemployment benefits 'shall be treated as if' they were wages. The Court explained that instructing something be treated 'as if' it were wages does not imply it categorically is not wages, much like saying all men should be treated as six feet tall does not mean no man is actually six feet tall.
- The Court traced the regulatory history showing Congress enacted Section 3402(o) to fix a narrow withholding problem — some severance payments tied to state unemployment benefits had been exempted from withholding by IRS rulings, leaving workers with large year-end tax bills — not to declare all severance pay outside the definition of wages.
- Relying on an earlier decision holding that 'wages' should generally mean the same thing for both income-tax withholding and FICA, the Court concluded that Section 3402(o) does not narrow FICA's broad definition, so the severance payments here remained taxable wages.
Doctrinal impact
Cases affected by this decision
Reaffirms Rowan Cos. v. United States (452 U. S. 247)
The Court relied on Rowan's principle that 'wages' should generally mean the same thing for both income-tax withholding and FICA.
Reaffirms Social Security Bd. v. Nierotko (327 U. S. 358)
The Court used this case's broad reading of 'service' to support treating severance pay as wages.