As of January 1, 2017, the taxable wage base increased to $127,200, up $8,700 from the $118,500 limit that had been in place since 2015. As a result, higher-income workers will pay more FICA taxes, and there is the possibility that companies will pay more FICA tax dollars in 2017 when paying severance. Did you know there is a way companies can be exempt from FICA tax altogether for employees involved in an involuntary reduction-in-force?

When a company considers layoffs, the leadership and HR teams have a lot to think about.  Who will be impacted?  What benefits will they receive and for how long?  How will the reduction-in-force impact the health of the business?  For many companies, one of the last considerations is one of the most important — what's the best way to help their former employees transition to new employment quickly and with the best support services? An Employment Transition Benefit ("ETB") Plan may be the answer.

Today, Fortune 1000 companies are seeking cost-effective alternatives to traditional severance plans.  They are finding that a proven sixty year old concept, Supplemental Unemployment Benefit ("SUB-Pay") Plans, may provide the answers. A SUB-Pay Plan can relieve a company of both the cost and administrative burdens associated with severance plans, as well as help their former employees gain more net income and transition to new employment quicker than with a traditional severance plan.

In today’s economic environment, reductions-in-force are not only unavoidable, but necessary in order for companies to meet the demands of  an ever-changing business and economic environment.  And, while no company wants to lay off any employee, there comes a time when layoffs must happen.

In what could be viewed as an “entitlement benefit,” the majority of companies in the United States prefer to provide a lump-sum severance benefit to their reduced workforce in order to provide a “cushion” to new employment.  Unfortunately, this type of severance, when coupled with the potential for the laid off employee to receive state unemployment insurance (UI) benefits simultaneously, may inadvertently encourage that former employee to stay out of work longer than is necessary. 

William Hays Weissman is an employment attorney and a shareholder at Littler Mendelson P.C., the largest global labor and employment law firm. An attorney with both an M.B.A. and Master of Laws (LL.M.) in Taxation, he specializes in employment taxes and counsels clients on the tax implications of various employer-provided benefits. William is also a noted advocate of an alternative severance program known as a Supplemental Unemployment Benefit (“SUB-Pay”) Plan.  Recently, Total Management Solutions asked William why he recommends SUB-Pay Plans to certain clients.

Expense reduction is an on-going priority for most employers today.  CFOs and finance departments are largely tasked with finding innovative ways to manage overhead costs.  Typical cost reduction efforts focus on cutting expenses such as headcount, materials, supplies, and other purchased items.  Compensation and benefits plans also are routinely examined to cut costs, but severance programs often escape the scrutiny of the finance department.  This is a missed opportunity to improve severance benefits and save significant dollars.

Businesses continue to experience long-term residual effects from the Great Recession.  Today, employers in virtually all industries are still assessing their workforce needs and are looking to attract and manage employees in the most cost-efficient and tax-effective manner possible.  As part of a broader workforce strategy, many companies are also focusing on how severance practices are impacting a company's brand as much as the bottom line.  Consequently, employers are reviewing their severance polices – many of which have remained unchanged for years – to find new value-creating opportunities that can also save money for their company and their separated employees at the same time.

Following the landmark US Supreme Court decision in United States v. Quality Stores, Inc., many companies have surmised wrongly that the ruling eliminates the opportunity for FICA tax savings in severance programs.  It is true that a direct consequence of the ruling was that more than $1 billion in FICA tax protective refund claims filed by employers across the country were not and will not be paid.  However, under the Court’s ruling, Supplemental Unemployment Benefits (“SUB-Pay”) Plans complaint with IRS Revenue Ruling 90-72 remain valid.  Simply put, traditional severance plans are FICA-taxable, and SUB-Pay Plans are not.

Companies planning future downsizings due to acquisitions, restructurings, or economic conditions need to reevaluate their severance strategies in light of the Quality Stores decision in order to maximize tax benefits to both their company and their employees.

In the face of increasing national and international competition, Fortune 1000 companies are continually assessing their corporate tax strategies to find new ways to maximize cash flow and reduce their tax burden.

Corporate finance departments often focus on employee benefit plans to look for ways to improve efficiencies, control costs, and increase tax savings.  CFO’s and tax specialists should also examine company severance plans to ensure that these programs are designed and administered on a tax-advantaged basis.  What many companies do not realize is that there is an IRS-compliant severance strategy that offers significant tax savings.

On March 25, 2014, the US Supreme Court ruled in favor of the IRS in United States v. Quality Stores, Inc. holding that severance payments are taxable as FICA wages.  The Supreme Court’s ruling also prevents taxpayers from receiving FICA refund claims.

However, severance paid as Supplemental Unemployment Benefits to involuntarily laid-off employees that is linked to the receipt of state unemployment insurance benefits, and not paid in a lump sum, is FICA exempt.

This latest article provides some insight in to the key takeaways employers can get from the decision in the Quality Stores case, and what to consider going forward when faced with a involuntary reduction-in-force.

In what many consider to be the most significant payroll tax opinion issued in the last 30 years, on March 25, 2014 the US Supreme Court ruled in favor of the IRS in United States v. Quality Stores, Inc. deciding that severance payments employers made to laid-off employees are “wages” and are taxable under FICA.  The immediate fallout from this decision is that more than $1 billion in FICA tax protective refund claims filed by employers across the country will not be paid.

Despite the rejection of FICA tax refund claims, under the Court’s ruling, Supplemental Unemployment Benefits (“SUB-Pay”) Plans complaint with IRS Revenue Ruling 90-72 remain valid.

The decade-long debate over whether or not severance paid to certain employees is considered wages for Federal Income Contributions Act (“FICA”) tax purposes is over.  On March 25, 2014, the US Supreme Court ruled in favor of the IRS in United States v. Quality Stores, Inc., deciding that severance payments employers made to involuntarily laid-off employees are “wages” and are taxable under FICA.

This latest TMS article on the Quality Stores case was featured in the Tax News section of Law360.com.  Please click here to read and download the article on Law360.com (subscription required) or click here to download a copy from TMS.

With the prolonged effects of a troubled economy, a state’s ability to keep its unemployment insurance (“UI”) trust fund solvent is a challenge.  When states exhaust their UI trust funds and borrow from the federal government to pay UI benefits, the results can extend to decreased UI benefits, a decreased amount of UI benefit weeks and an increase to the rate by which employers are taxed for federal and state unemployment taxes.

FUTA tax is automatically increasing by approximately $21 per year in states that fail to repay federal loans, and it’s projected to jump even higher for 2014.  FUTA tax is normally only $42 per employee in states with outstanding loans; however this amount may dramatically increase in 2014 to $84 to $196 per employee in those states that paid out more in state UI benefits in comparison to their UI tax rates.

TMS was recently featured in the Connecticut Bar Association's March 2014 tax newsletter.

TMS offered insight into how a Supplemental Unemployment Benefit (SUB-Pay) Plan can benefit employers and their displaced employees given the recent the U.S. Supreme Court's recent ruling in United States v. Quality Stores, Inc. case.

The U.S. Supreme Court’s decision in United States v. Quality Stores, Inc. is the most significant payroll tax opinion issued in the last 30 years, if not ever.  Not only does it put an end to the thousands of Social Security and Medicare (FICA) tax refund claims filed by employers on their own behalf and on behalf of millions of terminated workers, but it also may impact and limit the extent to which future downsized workers are eligible to receive state unemployment benefits.

A recent article by Mary Hevener and David Fuller, partners at Morgan Lewis, provide more information on the Court's decision, and how benefits made from a SUB-Pay Plan compliant with IRS Revenue Rulings are still FICA tax exempt.

Click here for the Morgan Lewis article.

This article was drafted by the attorneys of Morgan Lewis.  This information should not be relied upon as legal advice.

Page 1 of 3