Tax Law | Expert Legal Commentary

January 2, 2013

In re Quality Stores, Inc.: Sixth Circuit Excludes Some Severance Payments from FICA Tax

In re Quality Stores, Inc.

By H. Jacob Lager of Zuber Lawler & Del Duca

In re Quality Stores, Inc.: Sixth Circuit Excludes Some Severance Payments from FICA Tax

The Sixth Circuit has determined that some forms of severance payments are not taxable under FICA. In In re Quality Stores, Inc., No. 10-1563 (6th Cir. Oct. 6, 2012), the Court determined that payments made out of a company’s severance plans were SUB payments, which the Court concluded were not wages under FICA and not subject to tax.

Quality Stores (“Quality”) was a retailer serving farmers and gardeners.  In 2001, Quality closed its stores and distribution centers as part of bankruptcy proceedings.  Quality made severance payments under two plans to its employees who were involuntarily terminated – the pre-petition severance plan and the post-petition severance plan.  Under these plans, employees received varying amounts of severance pay based on their employment grade and length of service.

For tax purposes, Quality classified the severance payments as gross income, labeling them as wages on W-2 forms.  Quality also withheld federal income tax, paid the employer’s share of FICA tax, and withheld the employee’s share of FICA tax.  Quality then remitted the FICA taxes.

While Quality paid the FICA taxes, it did not agree with the IRS’ stance that the severance payments constituted wages under FICA.  Quality argued that the payments were actually SUB payments that were not taxable under FICA.  Quality filed for a tax refund from the IRS on behalf of itself and many of its employees, asking for a refund of $1,000,125, which included both the employer and employee share of the paid FICA taxes.  The IRS denied the refund claims, and Quality filed an adversary action in bankruptcy court.  Eventually, the case was appealed to the Sixth Circuit.

Court Finds Common Definition for Wages; SUB Payments Excluded

SUB payments are a type of severance payment defined by statute as (1) an amount paid to an employee; (2) pursuant to an employer’s plan; (3) because of an employee’s involuntary separation from employment, whether temporary or permanent; (4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee’s gross income.  I.R.C. § 3402(o)(2)(A) (numbering added).  The Court found that Quality’s severance payments met this five-part statutory test under stipulated facts.

Under FICA, employee wages are taxed to fund Social Security and Medicare.  The statutory definition, however, does not say whether SUB payments are “wages” under FICA and thus subject to FICA taxes.  To deal with this ambiguity, the Court looked to the definition of “wages” in a different part of the tax code: federal income tax withholding.

Using the tools of statutory analysis, the Court determined that SUB payments are not wages under income tax withholding law.  The Court first analyzed the title of the SUB payment statute § 3402(o), which reads “Extension of withholding to certain payments other than wages.”  The Court determined that the title’s reference to “payments other than wages” (emphasis added) clearly supported its conclusion that Congress knew it was making a distinction between wages and SUB payments.

The Court buttressed this finding by referring to the legislative history of the statute, in which Congress recognized that SUB payments “are not subject to federal income tax withholding because they do not constitute wages or remuneration for services.”  While Congress ultimately extended income tax withholding to SUB payments, it had to create a special statute to do so because SUB payments were not “wages” under the default withholding statutes and regulations.

The Court concluded that if SUB payments are not “wages” under federal income tax withholding, then they are not wages under the “nearly identical” definition of wages under FICA.  The Court relied on Rowan Cos. v. United States to reach this conclusion, arguing that the Supreme Court in Rowan determined that Congress intended for “wages” to have the same meaning under both FICA and income tax withholding regimes.  The Supreme Court reasoned that because Congress adopted nearly identical definitions of wages under FICA and income tax withholding, it intended to coordinate the two schemes “to promote simplicity and ease of administration.”

The Court rejected the government’s argument that the “decoupling amendment” of the Social Security Amendments of 1983 superseded Rowan.  While the Court acknowledged that the legislative history of the decoupling amendment aims to decouple the definition of “wages” between the two schemes, the actual text of the statute merely allows for the Treasury to promulgate different regulations for the exclusions from “wages” under FICA and income tax withholding.  The Court also found that the Treasury has never promulgated any regulations under the decoupling amendment.  Thus, the Court found that the plain reading of the statute did not supersede Rowan, and the case remained good law.

In the end, the Court affirmed the district court in siding with Quality.


The Sixth Circuit’s decision in Quality has broad implications for companies making severance payments to employees.  Companies doing so should contact experienced tax counsel to see how Quality may affect your tax liability.

About the Author

H. Jacob Lager is a Partner of Zuber Lawler & Del Duca, focusing on tax law.

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H. Jacob Lager

Companies Mentioned

Quality Stores, Inc.

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Companies Mentioned

Tax Law

The following companies are mentioned in Tax Law Updates:

Internal Revenue Service

Swallows Holding, Inc.

The State of New York

New York State Department of Taxation and Finance LLC

Amazon Services, LLC

Textron Inc.

County of Los Angeles


Quality Stores, Inc.

Agere Systems, Inc. f.k.a. Lucent Technologies, Inc.

Detroit Medical Center

Department of Justice

Santini Stone LLC

City of Chicago

StubHub, Inc.

Mayer Brown LLP d.b.a. Mayer, Brown, Rowe & Maw LLP

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