Bradley W. Joondeph is the Inez Mabie Distinguished Professor and Associate Dean for Academic Affairs at the Santa Clara University School of Law.

When exactly do severance payments constitute “wages” for purposes of the Federal Insurance Contributions Act (FICA)?  At a conceptual level, the answer would seem to be always.  Though such payments may not be attributable to the rendering of any particular services, they nonetheless represent cash compensation for prior contributions to the employer – especially when they are based on factors like an employee’s position and length of service.  But whatever might make sense conceptually, statutory cases turn, first and foremost, on the precise words chosen by Congress, and how those words – arrayed in different chapters and sections across a broad statutory scheme – are best harmonized to fashion a coherent whole.

Therein lies the rub of United States v. Quality Stores, Inc., scheduled for oral argument on January 14.   The payments at issue – “supplementary unemployment benefits” (or SUB payments) – seem to meet the statutory definition of “wages” set out in 26 U.S.C. § 3121(a), the provision which defines that term for purposes of FICA.  But another provision, 26 U.S.C. § 3402(o) – residing in a different chapter of the Internal Revenue Code – strongly implies that they are not wages for purposes of income-tax withholding.  And the Supreme Court (in Rowan v. United States (1981)) has stated that “Congress intended ‘wages’ to mean the same thing under FICA . . . and income-tax withholding.”

Quality Stores thus presents the Court with questions of varying breadth and implication.  Most immediately, the Court must resolve whether these disputed SUB payments are “wages” under FICA — a legally narrow issue, but one with substantial revenue implications.  (According to the government, “the amount at issue for this and other claims exceeds $1 billion and is expected to grow.”)  But the case also presents broader questions about the Court’s approach to statutory interpretation:  Should its analysis effectively start and end with the statutory text actually at issue (namely,

Section 3121(a))?  Or should it extend to inferences drawn from nearby provisions (namely, Section 3402(o)) – even ones largely irrelevant to the present dispute – so that the statutory scheme better coheres as a whole?  All the while, an important administrative law issue lurks in the background, one that could draw the Justices back into their ongoing debate over the role of administrative agencies in statutory construction:  What level of deference should courts afford positions taken by the IRS in its tens of thousands of revenue rulings?

*   *   *

Quality Stores, an agricultural-specialty retailer, entered into bankruptcy proceedings in 2001.  Near the time of its bankruptcy, it offered its employees various severance packages, all of which were calculated based on an employee’s position within the company, her salary, and her length of service. As stipulated by the parties, these payments (a) were made because of the employees’ “involuntary sep­aration from employment, resulting directly from a reduction in force or the discontinuance of a plant or operation”; (b) were “not tied to the receipt of state unemployment compensation”; and (c) were “not attributable to the rendering of any particular services.”  Quality Stores initially remitted to the IRS roughly $1 million in FICA taxes on these payments but later sought a refund in the same amount.  The IRS declined the request, and Quality Stores filed an adversary proceeding in bankruptcy court. The bankruptcy court held in favor of Quality Stores, and the district court affirmed.

On appeal, the Sixth Circuit held that the severance payments were not “wages” under FICA.  Writing for a unanimous panel, Judge Jane B. Stranch reasoned as follows: (1) the disputed payments are “supplemental unemployment compensation benefits” under Section 3402(o); (2) Section 3402(o) directs that such payments shall be treated “as if they are wages,” which means they are “payments other than wages” for income-tax withholding – otherwise there would be no need to treat them “as if” they were wages; (3) Rowan provides that “Congress intended the term ‘wages’ to carry the same meaning for purposes of FICA and federal income tax withholding”; thus, (4) these payments are not wages under FICA.  The Sixth Circuit’s decision created a clear split of authority, as the Federal Circuit had held, in CSX Corp. v. United States (Fed. Cir. 2008), that SUB payments like those made by Quality Stores are indeed wages under FICA.

The government’s position before the Court is relatively straightforward, consisting of two principal submissions.  First, the statutory provision directly at issue – Section 3121(a) – states that “‘wages’ means all remuneration for employment.”  This definition encompasses the payments at issue here:   They were based on an employee’s position, salary, and length of service.  That the payments were not for specific services is of no moment.  Under Section 3121(b), “employment” includes “any service, of whatever nature, performed . . . by an employee for the person employing him.”  And the Court has further clarified (in Social Security Board. v. Nierotko (1956)) that “‘service’ as used by Congress in this definitive phrase means not only work actually done but the entire employer-employee relationship for which compensation is paid.”  Moreover, Section 3121(a) specifically exempts a number of payments from treatment as wages, exemptions which everyone concedes are inapplicable here.  Under the principle of expressio unis, the existence of these exceptions shows that Congress intended these SUB payments to be wages.

Second, the government argues that the Sixth Circuit’s reliance on Section 3402(o) was misguided in two respects.  Again, Section 3402 addresses the obligations of employers for purposes of income tax withholding.  By its very terms, it “does not explicitly address, and has no logical bearing on, the determina­tion whether particular payments to terminated em­ployees are subject to FICA.”  Thus, even if the definition of “wages” under the two sections happens to diverge (a point the government does not concede), Section 3121(a)’s definition necessarily controls here.  What’s more, even if Section 3402(o) were relevant, the inference drawn by the Sixth Circuit was unwarranted. For many years, the IRS has taken the position (in a series of revenue rulings) that a specific subspecies of SUB payments (inter alia, those “linked to the receipt of state unemployment compensation”) are not wages under FICA.  Thus, Section 3402(o) merely directs employers to treat all SUB payments as wages, whether they are wages or not.  Hence, the proposition that Congress’s “as if” phrasing implies that no SUB payments constitute wages is logically flawed.

The arguments submitted by Quality Stores largely track the opinion below.  First, the “plain language of Section 3402(o) clearly recognizes that SUB payments are not wages,” a conclusion strongly supported by Coffy v. Republic Steel Corp.(1980), in which the Court stated that SUB payments “cannot be compensation for work performed” because “they are contingent on the employee’s being thrown out of work.”  Given the nearly identical language of Section 3121(a) and Section 3401(a) defining “wages” for purposes of FICA and income-tax withholding, respectively – an identity underscored by the Court in Rowan – the definition must be the same in both contexts.  Second, the exceptions spelled out in Section 3121(a) are beside the point; SUB payments do not fall within that section’s definition of “wages” in the first place.

Third – and perhaps most damning – Quality Stores contends that the government’s argument proves too much.  If the disputed payments constitute wages under FICA on the ground that they arose out of “the employer-employee relationship as a whole,” then all SUB payments must be wages.  Yet the government maintains – both in its briefing here and in a long series of revenue rulings – that some SUB payments are not wages.  Yet nothing in the statute’s text can justify this distinction among SUB payments.  At least implicitly, then, the government is asking the Court to defer to the IRS’s administrative decisions addressing the “wage” or “non-wage” status of various SUB payments.  But these rulings warrant no such deference.  Surely they are not entitled to Chevron-style deference, for Congress has never indicated that they should carry the force of law.  Moreover, given the inconsistency of the IRS’s position over time – not to mention its lack of grounding in the statute’s text – these rulings also lack the “power to persuade” under Skidmore.

*   *   *

The likely result in Quality Stores seems uncertain.  On the one hand, the government’s principal submission is strong:  The disputed payments appear to fall within Section 3121(a)’s definition of wages – the provision that is, after all, directly at issue.  While Quality Stores may have good reason to claim that Section 3402(o) establishes that SUB payments are not wages for income-tax withholding, Rowan does not conclusively establish that the term must carry the same meaning in both contexts, as that case addressed a form of compensation that was not even taxable income, let alone wages.  What’s more, the status of these sorts of payments under Section 3402(o) is purely academic; they plainly constitute taxable income on which employers must withhold, whether “wages” or otherwise.  Further, even if the Congress that enacted Section 3402(o) in 1969 believed that all SUB payments are “payments other than wages” for all purposes, it is unclear why that legislative assumption should control the meaning of Section 3121(a) – a provision enacted by a different Congress, many years earlier, and for purposes of implementing a very different tax.

But the Court might well be bothered by the apparent inconsistency in the government’s position.  The government’s view that some SUB payments (those “linked to the receipt of state unemployment compensation”) are not wages under FICA – even though that type of payment is not at issue here – is hard to square with its basic contention that Section 3121(a)’s definition includes all payments “aris[ing] out of the employer-employee relationship as a whole.”  It also seems to lack any clear support in the statute’s text.  The Court might therefore sense that the government is trying to have it both ways, carving out unjustified administrative exceptions to the general rule that it stands behind as deciding this case.  Such unease among the Justices might then propel oral argument onto terrain the government probably hopes to avoid – namely, the level of deference (if any) that courts owe to the IRS’s fluctuating revenue rulings on the subject (or to revenue rulings more generally).

All of which makes this case a little tricky – and an interesting window into the Court’s approach to statutory analysis.

Posted in U.S. v. Quality Stores, Featured, Merits Cases

Recommended Citation: Bradley Joondeph, Argument preview: When do severance payments constitute “wages”?, SCOTUSblog (Jan. 7, 2014, 11:15 AM),