Often in shareholder or partner disputes, whether in squeeze and freeze out situations or other conflicts, questions of severance arise. Among many other considerations, the issue of taxes can be overlooked. The treatment of severance payments for tax purposes varies from agency to agency.
Both the Internal Revenue Service (IRS) and the Illinois Department of Revenue (IDOR) treat severance pay as wages for purposes of individual income tax. It’s handled like any other income. The Illinois Department of Employment Security (IDES), however, does not consider severance pay to be wages. While this may seem inconsistent treatment on the part of the Illinois government, it works to the taxpayer’s advantage. Because the IDES does not treat severance as wages, receiving severance does not disqualify one for unemployment insurance.
Until a Supreme Court ruling issued yesterday, the question of severance payments and FICA taxes (taxes withheld from income and used to fund Social Security and Medicare) was somewhat uncertain. In the case of United States v. Quality Stores, however, the Supreme Court has clarified the issue. After three lower courts held in Quality Stores’s favor that severance payments were not subject to FICA, and thus Quality Stores was entitled to a refund of the payments it had made to the IRS, the Supreme Court reversed those decisions and held that severance payments meet the plain definition of wages as provided by the Federal Insurance Contributions Act. Moreover, within the Act’s long list of exceptions, severance payments made because of retirement for disability are specifically exempted. There would be no need for such a provision, the opinion argues, unless severance payments were generally subject to tax.
Horowitz Law Offices represents shareholders and partners to help them litigate and resolve their difficult disputes. You are welcome to contact us at (312) 787-5533 or firstname.lastname@example.org