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Payroll taxes: severance pay issue is part of broader debate

The partial shutdown of the federal government will soon enter its third week. The IRS is of course affected, with the bulk of the agency’s workers furloughed.

Those furloughed workers included the ones who offer assistance to the public. And yet the October 15 filing deadline remains in place for taxpayers who had received a 6-month extension on their income tax returns.

The impact of the shutdown on the nation’s economy depends, in part, on how long the shutdown continues. The longer it goes on, the more likely it is that it will harm the economy – which could result in not just furloughed federal workers, but layoffs in the private sector and in state and local government agencies as well.

In this post, then, let’s look at the issue of how severance pay is treated for tax purposes.

On October 1, the date the shutdown began, the U.S. Supreme Court announced that it would hear arguments in a case called United States v. Quality Stores. The case raises the question of whether severance payments made by an employer to employees following involuntary layoffs are subject to Social Security and Medicare taxes.

Those taxes are imposed under a law called the Federal Insurance Contributions Act, otherwise known as FICA. The lower federal courts have reached different conclusions on whether severance payments to employees following involuntary layoffs are subject to FICA.

The larger question, as some commentators have pointed out, is whether imposing hefty payroll taxes really makes sense in an economy in which more and more workers are independent contractors rather than employees. After all, payroll taxes do not only include Social Security and Medicare taxes. They also include unemployment taxes and workers’ compensation taxes.

Source: Bloomberg, "Taxes on Severance Payments Draw U.S. High Court Review," Greg Stohr, October 1, 2013

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