Supreme Court to decide once and for all (hopefully) if severance pay is taxable

These days, terminated employees receiving severance packages happen quite frequently. Sometimes it happens voluntarily, such as during a layoff; other times, it happens after the employee has won a lawsuit against his or her company. It could even be required by state or federal law, or be part of a company’s policy.

Severance pay is basically a sum of money given to an employee to help a terminated employee help the ex-employee cover a period of time they may be unemployed.

There is currently a debate going on having to do with how (and in how many different ways) this money should be taxable (source).

Of course, it’s considered income so it’s subject to the usual income tax and other withholdings. The question becomes, “Should a severance package also be subject to payroll taxes?”

It is no shock that the Internal Revenue Service believes it should be. Many feel they’re already paying enough. Think about it: employees pay 6.4% of their salary, while employers are on the hook for 6.2%. Add in the extra Medicare monies, and you have around 15% of a sizeable check at stake.

There are currently two cases pending in the Supreme Court. Each case conflicts the other. This material is too much to include here, but you can see the two cases for yourself here.

It will be fascinating to see the outcome, because if past history is any indication, even the courts have a difficult time making a cohesive decision. In 2002, the Court of Federal Claims said no; but in 2008, The Court of Appeals for the Federal Circuit reversed the decision.

Then in 2012, Quality Stores went into Chapter 11 bankruptcy and gave severance to many terminated employees. The Sixth Circuit Court in this case said severance pay wasn’t wages and therefore wasn’t taxable. However, Quality Stores opted to withhold federal income and employment tax – and paid it to the IRS. Bankruptcy Court ruled the severance payments were not wages, and the Sixth Circuit upheld the decision … and now it will soon fall into the laps of the highest court in the land.