In United States v. Quality Stores, the Supreme Court last week made clear that severance payments are to be treated as wages for the purposes of taxation. In the Quality Stores case, a large number of employees received severance when the stores filed for chapter 11 bankruptcy protection. Their effort to get a refund of the FICA payments (the withholdings for social security and medicare) was rejected. The payment amounts varied according to how long the person had worked for the company, and how many years of service he or she had. The severance payments looked like wage replacements, therefore, and social security tax must be withheld.
This case does not prevent an employer from settling discrimination cases with a blend of compensatory and wage payments. Under current law, both are taxable, but compensatory damages do not require an additional payment of FICA taxes. Severance plans, however, like the one in Quality Stores, do not presume emotional distress but seek to soften the blow of a job loss with a set amount of replacement salary. They are enough like wages that they are to be taxed the same.