According to the Internal Revenue Service (IRS), severance is subject to Federal Insurance Contribution Act (FICA) tax and certain supplemental unemployment benefits are not. That’s right, employers can provide today, just as they have for years, termination benefits that are FICA-tax exempt. One of the primary benefits of providing termination benefits that qualify for the IRS-recognized exclusion from FICA tax is that those benefits typically do not impact the employee’s eligibility for, or amount of, state unemployment benefits.
The IRS’s position in the United States v. Quality Stores, Inc. case is that “supplemental unemployment compensation benefits,” as defined in Internal Revenue Code section 3402(o), and other severance payments are not FICA-tax exempt. On the other hand, the IRS’s administrative position, pursuant to IRS revenue rulings and private letter rulings going back to the 1950s, is that supplemental unemployment compensation benefits paid under a properly designed and administered plan is not subject to FICA or Federal Unemployment Tax Act (FUTA) taxes. For purposes of this blog series, supplemental unemployment compensation benefits that are exempt from FICA and FUTA taxes pursuant to the IRS’s administrative position are referred to as “traditional SUB-Pay” or “SUB-Pay.”