As if getting laid off from a job isn’t bad enough, Uncle Sam can now take a chunk of your severance pay, too.

In a reversal of lower court rulings, the U.S. Supreme Court decided this week that severance payments are subject to payroll tax under the Federal Insurance Contributions Act (FICA).

Quality Stores, an agricultural-specialty retailer that initiated the civil case, made FICA payments on behalf of its workers when it paid them severance.  The company later filed for a $1 million refund from the Internal Revenue Service, arguing that the severance was non-taxable income.

The plaintiff had won its case before the Sixth Circuit Court of Appeals, as well as other courts. But the Supreme Court took a different view of severance under FICA.

“A specific exemption under FICA for certain termination-related payments reinforces the conclusion that the payments in question are well within the definition of wages,” Justice Anthony Kennedy wrote for the court.

“The severance payments here were made to employees terminated against their will, were varied based on job seniority and time served, and were not linked to the receipt of state unemployment benefits,” Kennedy added. “Under FICA’s broad definition, these severance payments constitute taxable wages.”

Robert Hertzberg, attorney for Quality Stores, called the ruling “a huge blow for employers and employees alike.”

“In addition to the impact on Quality Stores and its former employees, this ruling has far-reaching implications for the thousands of other organizations and workers fighting for refunds,” Hertzberg said in a prepared statement.

-Noel Brinkerhoff

To Learn More:

Justices Say Severance Payments Must Be Taxed (by Barbara Leonard, Courthouse News Service)

High Court Rules Quality Stores Severance Pay Subject to FICA (by Peg Brickley, Wall Street Journal)

United States v. Quality Stores (U.S. Supreme Court) (pdf)