The recent U.S. Supreme Court's decision in United States v. Quality Stores, Inc. resolved a disagreement among the U.S. Courts of Appeal about whether severance payments are subject to taxes required under the Federal Insurance Contributions Act (FICA).  The Court held that severance payments are taxable "wages" for FICA tax purposes. This decision means that an employer who pays severance to a terminated employee must withhold and pay the employee's share of the FICA taxes and must pay the employer's share of the FICA taxes on the severance pay.

The Court, however, did not rule on whether the requirement for FICA tax withholding applied to severance payments which are part of a supplemental unemployment benefits ("SUB") plan. A SUB plan provides additional payments to employees who are receiving unemployment benefits because of an employee's involuntary separation from employment (whether or not such separation is temporary) due to a reduction in force, the discontinuance of a plant or operation, or other similar conditions. SUB plans have been around for many years and have been common in the automotive industry. Years ago the IRS ruled that severance payments made in connection with SUB plans are not "wages". Based on this IRS ruling, severance payments from a SUB plan have not been subject to FICA and income tax withholding. Because an employee might be subject to a big income tax bill for the tax year, Congress passed a law that required income tax withholding, but Congress did not address FICA tax withholding.

In summary, it appears that employers have the option of using a SUB plan to eliminate FICA tax obligations and thereby reduce severance program costs, at least until the IRS changes its position on this issue.