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The Impact of the Supreme Court’s Decision on Manufacturing and Distribution

After years of lower court decisions unfavorable to the Internal Revenue Service (“IRS”), the U.S. Supreme Court (“the Court”) ultimately sided with the IRS regarding severance pay considered as wages. As a result of the Court’s ruling, severance pay is now considered wages and subject to FICA tax. Let’s explore the impact of this decision and tax planning strategies for employers.

Background of the Decision

Previously, severance pay was not considered as wages. Thus, severance pay was not subject to FICA withholding. Now, due to the United States vs. Quality Stores ruling, both the employee and employer must pay FICA, or Social Security and Medicare tax, on severance pay. This increases the tax obligation for both the employee and employer.

Before the case was brought to the Court’s attention, employers filed refund claims to recover any overpayment of FICA taxes. These outstanding refund claims will now be closed out. No additional action is required from employers on these outstanding refund claims.

Tax Planning Strategies

One tax planning strategy available to employers is to accelerate payment of anticipated FICA taxes. If employers expect to lay off employees in the next tax year, they can pre-fund the FICA expense in a trust. If FICA payments are less than anticipated, the funds held in the trust can be used for other employee related benefits such as medical expenses. A safe harbor limit for reasonable severance pay also exists. It is 75 percent of the severance paid for any two of the seven preceding years.

The maximum severance pay amount is $78,000 per employee in 2014. This amount is adjusted annually for cost-of-living increases.

If you have specific questions on how this ruling may impact your business, please contact one of our Manufacturing & Distribution professionals.

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