Bethesda, Md

The Third Circuit has determined that certain severance payments to tenured faculty and administrators constitute “wages” for purposes of §3121, which governs employer and employee contributions under the Federal Insurance Contributions Act (FICA). In University of Pittsburgh v. U.S., No. 06-1276 (3d Cir. 11/2/07), the Third Circuit held that the relinquishment of tenure rights did not alter the payments' character as compensation for services subject to FICA taxes.

The two other federal circuits that have addressed such payments are split as to whether payments made by an employer to an employee in exchange for the relinquishment of contractual and constitutionally protected rights, such as tenure at a state university, constitute wages subject to the FICA tax. In North Dakota State Univ. v. U.S., 255 F.3d 599 (8th Cir. 2001), the Eighth Circuit determined that payments by a state university under an early retirement program to tenured faculty members in exchange for tenure rights were not wages subject to FICA tax. In contrast, the Sixth Circuit in Appoloni v. U.S., 450 F.3d 185 (6th Cir. 2006), cert. denied, 127 S. Ct. 1123 (2007), decided that employee severance payments to tenured public school teachers were FICA wages, as longevity was a key eligibility factor for participation and relinquishment of tenure was “a necessary and incidental part” of the buyout. Unlike the tenure requirements in North Dakota, tenure under state law in Appoloni was tied exclusively to the employee's performance of past satisfactory services.

In the University of Pittsburgh case, the Third Circuit cited three major factors in support of its decision: (1) the eligibility requirements were linked to past services, not the relinquishment of tenure; (2) the severance plans themselves made clear that the payments were viewed as compensation for service; and (3) the main purpose of the payments was to provide for employees' early retirement. The court accordingly remanded for entry of summary judgment in favor of the government.

The IRS position on this subject is detailed in Rev. Rul. 2004-110, 2004-2 C.B. 960. According to the IRS, “[e]mployment encompasses the establishment, maintenance, furtherance, alteration, or cancellation of the employer-employee relationship.” A separation payment does not constitute wages for purposes of FICA, however, “[i]f the employee provides clear, separate, and adequate consideration for the employer's payment that is not dependent upon the employee-employer relationship and its component terms and conditions.” In AOD 2007-01, the IRS stated that, in light of Rev. Rul. 2004-110, it will follow the North Dakota decision in the Eighth Circuit only for cases with the same exact facts to the extent that payments were made before January 12, 2005.

For more information, in the Tax Management Portfolios, see Allman, 392 T.M., Withholding, Social Security and Unemployment Taxes on Compensation, and in Tax Practice Series, see ¶5440, Employment Tax Withholding Requirements.