Generally severance payments made to terminated employees have been held by the US Tax Court to be FICA wages because the definition of “wages” for FICA purposes found in the Internal Revenue Code is so broad. “Wages” include all remuneration or money paid for employment with 23 listed statutory exceptions to the definition.
A federal district court case case I blogged about before, US v. Quality Stores, Inc. from the western district of Michigan provides a FICA exception for one small area of severance pay. Specifically, the federal court found a FICA exception for severance pay which constitutes “supplemental unemployment compensation benefits” within the meaning of Section 3402(o) of the Internal Revenue Code defined as amounts paid to an employee because of an employee’s involuntary separation from employment resulting directly from a reduction in work force, the discontinuance of a plan or business operation.
When you retire from employment and your separation is not the direct result of a reduction in work force or operational shut-down your retirement is usually NOT considered involuntary and as such your severance pay can be subject to FICA taxation if you have not hit the income threshold for the tax year.
Furthermore it is important to note that the IRS disagreed with the Quality Stores decision described above. On June 18, 2010, the IRS issued an opinion which refers to the Quality Stores decision by stating “the decision is not binding precedent,” and “the opinion runs counter to (a) Federal Circuit Court of Appeal’s 2008 decision.” Which means in plain terms from my perspective that the IRS will dedicate resources to defending their position on this matter the next time a case like Quality Stores comes up. In other words chances are really good that your severance payment will more likely than not be subject to FICA tax.