Cross References
• Quality Stores, Inc., 6th Circuit Court of Appeals, September 7, 2012

A recent court ruling said payments made by a bankrupt retail business to its employees pursuant to pre- and post-bankruptcy severance programs were supplemental unemployment compensation benefits (SUB payments) not subject to the Federal Insurance Contributions Act (FICA taxes).

In October 2001, Quality Stores, Inc. underwent Chapter 11 bankruptcy proceedings. Quality Stores made severance payments to those employees whose employment was involuntarily terminated. Quality Stores made the severance payments pursuant to two separate plans.
• Pre-Petition Severance Plan. The number of weeks of severance pay an employee could receive was based on job grade and management level in the organization. These payments were not tied to the receipt of state unemployment compensation, and they were not attributable to the provision of any particular services by the employees.
• Post-Petition Severance Plan. This plan was designed to encourage employees to defer their job searches and dedicate their efforts and attention to the company by assuring them that they would receive severance pay if their jobs were eliminated. To be eligible for severance pay, an employee was required to complete the last day of service as scheduled. These payments were not tied to the receipt of state unemployment compensation, nor were they attributable to the provision of any particular services. They were paid in a lump sum, however, because the company was liquidating and it was not practical administratively to pay the amounts over time.

Quality Stores did not require employees to prove that they were unemployed in order to receive severance pay under either plan.

Quality Stores did not agree with the IRS that the severance payments constituted wages for FICA purposes. Quality Stores took the position that the payments made to its employees pursuant to the plans were not wage, but instead constituted SUB payments that were not taxable under FICA.

The Court looked at the history of SUB payments and noted that previous courts have said they cannot be compensation for work performed because they are contingent on the employee being thrown out of work. Unless the employee is laid off, he will never receive SUB payments. The cost to an employee of losing his job is not measured by how much work he did in the past, but by the rights and benefits he forfeits by giving up his job. SUB payments are in the nature of a reward for length of service and do not represent deferred short-term compensation for services actually rendered. On the other hand, back pay granted to an employee does constitute wages which are taxable under FICA.

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