FICA Withholding on Severance Pay

For taxpayers considering a reduction in force, a recent Supreme Court decision may affect how those taxpayers withhold FICA tax on any severance payments that might be made in that reduction.

The Supreme Court case ruled that severance payments are considered “wages” when made as part of a reduction in force payment.  As such, these severance payments are subject to the Federal Insurance Contributions Act (FICA).  There had previously been a split in the lower circuit courts as to whether or not severance payments were, in fact, wages subject to FICA withholding.

In the lower courts the dispute resulted from the FICA rules as it applied to wages.  Under the rule FICA withholding is for “wages with respect to employment.”  The logic being that a severance payment, by definition, was not with respect to employment because, well, the employee was no longer employed.  The Supreme Court did not see it that way, relying on precedent that stated wages included any payments that involved the employer/employee relationship.

This ruling can make a substantial difference in the amount of net take home pay received by a terminated employee as well as the taxes the employer will have to pay.

If you are facing the unfortunate situation of having to make a reduction in force and want to reduce the tax consequences, schedule your free consultation by calling (480) 888-7111 [or submit a web request here].