FICA taxation of post-employment benefits: a statutory puzzle and sociopolitical conundrum.

• Author: Stein, Amanda
• Position: Federal Insurance Contributions Act

1. An Introduction to the Sociopolitical Conundrum

   "Great cases, like hard cases, make bad law." (1) One might wonder, then, what can be expected of cases that are both great and hard? This Note discusses such an issue--the imposition of FICA tax on severance payments--and the result has been cases that present highly technical, reasoned analyses with conflicting conclusions. While it may seem doubtful that this issue deserves such an admittedly dramatic description, (2) upon closer inspection, it appears warranted: this issue involves sympathetic stakeholders on both sides, the political minefield of the payroll tax, the complexity of the tax code, conflicting legal authority, and a sensitive, post-recession economic backdrop, and now, an imminent Supreme Court case.

   The 2012 election cycle and the political negotiations arising from the attempt to avoid the "fiscal cliff' shortly thereafter (3) reignited debate on the role of social insurance programs and notions of shared responsibility. The expiration of a payroll tax cut, effective January 1, 2013, (4) also reminded working Americans of their own role in funding Social Security and Medicare, and, to some, signaled a political calculation that the Social Security and Medicare programs need that extra percentage of taxpayers' income more than the taxpayers do. (5) At the heart of all of this discussion is the Federal Insurance Contributions Act (FICA), the chapter in the tax code that created a payroll tax on employees and employers to contribute to the funding of Social Security and Medicare programs. (6)

   The taxation of severance payments, in particular, adds a layer of complexity to the sociopolitical issues that are already presented by FICA, Social Security, and Medicare. On the one hand, furthering the lofty goals of Social Security and Medicare and continuing to provide much-needed support to elderly Americans might suggest the need to reach as broad of a tax base as possible. On the other hand, severance payments are an especially delicate source of income. As our country emerges from a recession, many Americans are unemployed; those fortunate enough to receive some form of severance payment from their former employers may be without another source of income for an extended period of time, thereby making a tax on that severance payment particularly burdensome. (7) It becomes clear that there are many conflicting interests at stake and that no matter how the calculation is resolved, one side faces a discernible loss of revenue or income at a time when neither can afford it. (8)

   This particular issue, whether severance payments are "wages" subject to FICA taxation, has been characterized as a "straightforward, but legally-confounding question," (9) but, as will be discussed, it is generous to refer to this issue as "straightforward" at all. In September 2012, the Sixth Circuit decided In re Quality Stores, (10) holding that the payments were not taxable. Because the Federal Circuit had previously held that the payments are taxable as wages," most recently in the 2008 case CSX Corporation v. United States, (12) the Sixth Circuit opinion created a circuit split. With such complex political, social, and economic interests implicated in the determination that severance payments are (or are not) subject to FICA tax, a disagreement among the circuit courts of appeal creates a renewed urgency for due consideration of the Social Security and Medicare programs and the FICA tax that funds them.

   In Part II, this Note examines the historical context of Social Security and Medicare, subsequently providing a descriptive overview of FICA and the severance payments at issue. Part III discusses the factual background of In re Quality Stores (13) and CSX Corporation v. United States, (14) the cases that created a circuit split on the issue of withholding FICA tax from severance payments. Part IV will introduce each component of the relevant authority on this issue and will undertake a detailed analysis of the courts' treatment of the authority. Finally, in Part V, this Note will weigh the competing interests and various options and propose both a short-term solution for courts and a long-term solution for Congress.

2. HISTORY AND BACKGROUND: THE MAKINGS OF A "GREAT CASE" (15)

   1. Social Security and Medicare: History, Status, and Sustainability

      With all discussions of normative desirability and feasibility aside, Social Security and Medicare play an important role in the lives of the programs' beneficiaries and in our society. (16) To understand the political, economic, and social importance of Social Security and Medicare, one must understand their background. These programs were enacted only after great difficulty and remain a proud accomplishment of our political system, despite any discord surrounding their present operation. The political discourse from the beginnings of both of these programs is strikingly similar; there is a recurring sense of urgency and social necessity followed by a deep appreciation of the difficulty of their design and enactment. (17)

      1. A Brief History of Social Security

         The Social Security Act, (18) enacted in 1935, was designed to protect against the "hazards and vicissitudes of life." (19) As the first comprehensive social welfare policy, "[t]he Social Security Act provided a policy framework for administering retirement and unemployment insurance as well as providing welfare payments to aged adults, the disabled blind, and children." (20) Upon signing, President Roosevelt recognized the attempt "to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age." (21)

         Despite constitutional challenges, the Social Security Act has been upheld as within Congress's power to levy a tax for the promotion of the general welfare. (22) In validating the constitutionality of the tax imposed on wages to fund Social Security, the Supreme Court echoed the theme of necessity, noting, "the number of the unemployed mounted to unprecedented heights" and declaring, "[i]t is too late today for the argument to be heard with tolerance that in a crisis so extreme the use of the moneys of the nation to relieve the unemployed and their dependents is a use for any purpose narrower than the promotion of the general welfare." (23)

         The implementation program for Social Security is, in essence, a "contractual relationship between those who worked and were taxed to ensure economic benefits for themselves and their dependents." (24) Many studies have attempted to address "whether an individual or group of persons can expect to get a 'fair' return in the form of benefits for the tax contributions made." (25) Recognizing that the program is designed "to provide a minimally adequate 'floor of protection'" for low-earning workers in addition to "a reasonably equitable return for even the highest-paid workers," it is noted that the structure creates "divergent rates of return for different groups of workers." (26) Notably, however, the "monetary and social value of the program to higher-paid workers transcends the amount of benefits that they may personally expect to receive." (27) Under this view, even if the financial returns are lower than a private investment or annuity, there is a discernible benefit to all workers. (28)

         Although it "resembles its original form," the Social Security Act has "expanded beyond anything envisioned by its 1935 developers." (29) As of June 30, 2013, there were approximately 57,469,000 beneficiaries, and eighty-eight percent of the population over the age of sixty-five received Social Security benefits. (30) Still, Social Security is "a cornerstone in a structure [that is] by no means complete" on its own. (31) Medicare adds to that structure.

      2. A Brief History of Medicare

         Medicare was signed into law on July 30, 1965. (32) In his remarks on the date the bill was signed, President Johnson paid homage to the foundational work in the passage of the Social Security Act, echoing its rhetoric and crediting the efforts of President Truman twenty years earlier. "[T]he need for this action is plain", he said, "and it is so clear indeed that we marvel not simply at the passage of this bill, but ... that it took so many years to pass it." (33)

         Medicare is a complex program, the intricacies of which are beyond the scope of this Note. (34) At its core, however, Medicare provides certain health insurance to individuals over age sixty-five, and to certain disabled individuals under age sixty-five. (35) Medicare "Part A" provides hospital insurance, (36) and "Part B" provides supplementary medical insurance benefits. (37) Medicare "Part C," also known as "Medicare+Choice" provides an alternative to Parts A and B and allows beneficiaries to receive their insurance benefits from certain private providers. (38) Medicare "Part D" provides prescription drug coverage. (39)

         Medicare's primary purpose is fundamentally different from that of Social Security--it endeavors to provide federal health insurance to the elderly, rather than provide retirement income. (40) Medicare is funded in part by payroll taxes, just like Social Security, but because of its different purpose, the logic of a Medicare payroll tax is different from the basis of Social Security. (41) While a Social Security payroll tax is premised in part on a contractual relationship between those who work and the Social Security Administration, thus creating an earnings-related benefit, a Medicare payroll tax takes the form of social insurance. (42)

      3. The Status and Sustainability of Social Security and Medicare

         Despite a steady increase in the payroll tax rate over time, (43) projections show that Social Security and Medicare "are not sustainable under currently scheduled financing and will require legislative action to avoid disruptive consequences." (44) Naturally, the 2012 election cycle...