Taxable and Non-Taxable Portions of Severance Pay

This article deals with whether employers must pay front pay severance payments as W-2 wages or whether employers are allowed to pay the front pay severance as 1099 income. Furthermore, it delves into the question of whether or not all of the severance pay is subject to FICA tax in addition to ordinary income tax. There have been conflicting revenue rulings and conflicting professional (non-IRS) opinions on whether or not employers are allowed to pay front pay severance payments in the form of 1099 compensation (letting the terminated employee pay all taxes).

Previous Cases

Prior to a March 25, 2014 Supreme Court decision (named below), there was a split among federal circuit courts as to whether or not severance payments were wages subject to FICA taxes. The Supreme Court decision on March 25, 2014 resolved a circuit split created when the Sixth Circuit ruled in 2012 that severance payments did not constitute “wages” under FICA while the Third and Eighth Federal Circuits had all previously held that at least some severance payments are wages subject to FICA taxes. The Supreme Court held in the decision issued March 25, 2014 in United States v. Quality Stores, Inc., No. 12-1408, that severance payments, for work not performed (front pay severance), paid to employees who are involuntarily terminated are taxable wages for purposes of withholding FICA taxes. Severance pay may comprise of multiple elements, each of which may or may not be wages, such as back pay, front pay, payment for emotional distress. Both back and front pay severance payments are wages subject ordinary income and FICA taxes.

Relevant Regulations

Sections 3121(a) and 3306(b) of the Code, relating to FICA and FUTA taxes, provide, with certain exceptions, that the term “wages” means all remuneration for employment.

Section 31.3401(a)-1(b)(4) of the Employment Tax Regulations provides that any payments made by an employer to an employee on account of dismissal, including involuntary separation from the service of the employer, constitute wages for income tax withholding purposes. Under Section 31.6051-1(a)(1), the wages of an employee that are subject to social security and Medicare taxes are included in the appropriate boxes on the Form W-2 issued to the employee.

Unless otherwise excluded, remuneration for employment constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services were performed and the individual who performed them.

The Internal Revenue Code Section 3402(a) provides that an employer is required to withhold income tax on remuneration for employment wages paid to its employees. Section 6051 of the Code requires payers of remuneration to an employee to report those payments on Form W-2.


The Supreme Court’s decision on March 25, 2014 and the revenue rulings and treasury regulations support the employer obligation to pay severance payments as W-2 wages with employers having an additional obligation to withhold taxes from the pay. Employees’ front pay severance is subject to ordinary income and FICA taxes. Employees’ front pay severance should be reported to employee on a W-2, and Employers have withholding tax obligations.

Candice Wagner, Attorney