Should Severance Pay Be Subject to FICA Taxes?

October 8, 2013 | By: TaxCure Staff

severance pay and taxesRight now, there is a debate raging over whether or not severance pay should be subject to FICA taxes. It’s a tough call because it all depends on whether or not severance pay is considered wages, and whether or not the pay is for services that you provide to the company.

Wages and FICA Taxes

This is an important distinction because wages are subject to FICA taxes. Severance pay is considered income, and it is subject to the “regular” income tax. That’s not a question. Instead, the question lies in whether or not severance pay is something you receive for “rendering services.”

If you aren’t receiving the pay for “rendering services,” then it’s not subject to FICA taxes (which include the Medicare tax and the Social Security tax). However, if you are “rendering services,” then FICA is in effect. Not only would you have to pay the employee side of FICA on the money you receive as part of the income, but your former employer would also have to pay its side of the FICA taxes.

As a result, employers and ex-employees are on the same side with this one. They want severance pay seen as income, but not described as wages. The IRS, in its quest for revenue, though, wants to see severance pay subject to payroll tax.

The Supreme Court Will Decide

Two different cases have been wending their way through the court system over the past two years. In one instance, the ruling is that severance pay should be subject to FICA taxes, and the other case has a ruling that says that severance pay isn’t for “services rendered” because, clearly, the pay comes after the employee has stopped providing services to the employer.

As a result of these conflicting views, the Supreme Court will decide between the two cases, and whichever the justices agree with will become the law of the land.

What to Do in the Meantime

For now, pay attention. It might make sense to go ahead and have your FICA taxes withheld from your severance pay. After all, if the Supreme Court decides that severance pay isn’t subject to FICA, you can get a refund. If the Supreme Court goes the other way, you might end up owing quite a bit.

The IRS is already withholding administrative refund claims in the area affected by the ruling that says that severance pay isn’t subject to FICA. The IRS is hoping that the Supreme Court will rule that way. In other areas, the IRS isn’t even allowing refund claims related to withheld FICA taxes.

It also makes sense to consult with a knowledgeable tax attorney on this issue. In some cases, you might be facing statutes of limitations while you wait for the Supreme Court to decide on this issue. If you have severance pay, consult with a tax professional about what you should do when it comes to making sure your rights are protected, as well as making sure that your financial situation isn’t made too troublesome by whichever turn these cases take.