Teacher severance pay not subject to FICA.

• Author: Klender, Phyllis
• Position: Federal Insurance Contributions Act

Ps are public school teachers who achieved tenured status. Because long-term teachers command higher salaries than newer employees, their school districts offered severance plans to induce senior teachers to separate from the district in exchange for a fixed sum payable in regular installments. Each severance plan required the teacher to relinquish his or her right to continued employment as a tenured teacher under Michigan law; some of the plans limited the teachers' rights to seek re-employment with the district. Ps agreed to participate, and the school districts withheld FICA taxes from the payments. The teachers contend that the payments were not "wages" within the meaning of FICA, and sought a refund. When the refunds were refused, this suit was commenced and certified as a class action.

Discussion

Sec. 3101(a) imposes on every individual a Social Security tax on all "wages" received "with respect to employment)' Under Sec. 3121(a), "wages" means all renumeration for employment, including the cash value of all renumeration (including benefits) paid in any medium other than cash. The IRS argues that, under Sixth Circuit law, the phrase "remuneration for employment" should be interpreted broadly and must "include certain compensation in the employer-employee relationship for which no actual services were performed" (Gerbec, 164 F3d 1015, 1026 (6th Cir. 1999)). However, Ps believe that Gerbec does not control here, because they relinquished a tangible property interest in exchange for the payments; they rely on an Eighth Circuit decision (North Dakota State Univ., 255 F3d 599 (8th Cir. 2001)).

North Dakota: In that case, North Dakota State University (NDSU) offered an early retirement program to certain tenured faculty and high-level administrators. The district court determined that the retirement payments to NDSU administrators were FICA wages, because the administrators were "at will employees." However, the tenured faculty members had a recognized property interest in their tenure. The district court concluded that the payments to tenured faculty were made in exchange for the relinquishment of a property or contract interest, rather than for compensation and, as such, were not subject to FICA taxation.

In affirming the district court, the Eighth Circuit looked to the Service's determinations on whether FICA taxes were owed on severance payments made under a variety of circumstances (e.g., Rev. Rul. 58-301 (determining that FICA taxes...