A Tax Win for Downsizing Firms
Laid off workers also gain in a stunning district court decision.
Good news for businesses that are downsizing or already have: You may be due money back from the IRS. A district court has ruled that severance pay given to terminated workers is not subject to Social Security and Medicare taxes. Workers who had taxes deducted from their severance could also get that money back.
Don’t go spending your refund yet, however. The IRS is certain to appeal the ruling, so the fight on this issue is far from over. But you can protect your interests by filing what’s known as a protective refund claim, using IRS Form 843. The IRS will set these claims aside until after all appeals are decided. Claims can be filed by firms that paid severance to laid off workers within the three-year statute of limitations for tax returns. Acting quickly is especially important for businesses that paid severance back in 2006 because the statute-of-limitations window for them will run out next month, on April 15.
The case in question involves a retailer that closed all its stores and let its staff go, paying them severance. The retailer challenged IRS’ finding that Social Security and Medicare taxes were owed on the payments, and the U.S. District Court for the Western District of Michigan sided with the store. The court noted that the tax code specifically requires employers to treat severance paid to laid off workers as if it were wages for income tax withholding purposes. In the court’s view, this indicates that severance pay is not otherwise to be treated as a payment of wages, and thus is exempt from payroll tax. The court also disagreed with the IRS’ position that severance pay avoids the tax only if that pay is tied to receipt of unemployment benefits.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.

Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
If the IRS loses all appeals, employees also would get back their portion of Social Security and Medicare taxes. Employers and employees are both responsible for half of the tax that must be deducted from paychecks and remitted to the government. Employers can choose to file a protective refund claim just for their half, but they may opt instead to file for the employee’s half, too. In the latter case, they could file one of two ways: They could either remit the employee half to the worker before filing a claim and then keep the entire amount of the refund when and if it ultimately comes. Or they could get written consent from workers to file for their half and agree to remit that portion to workers after receiving the funds from IRS. Employees can file protective refund claims on their own for their half of the tax if they don’t want their former employer to file for them.
For companies considering downsizing in the future, watch the court proceedings carefully, but keep paying your taxes. Until the appeals process is exhausted, IRS still has the right to demand timely payment of Social Security and Medicare taxes on severance pay.
What will it take to win a FICA tax refund for your firm and your ex-employees?
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
-
Amazon Ends Free Shipping Benefit Sharing with Non-Household Members
Starting October 1, Prime members will no longer be able to share shipping perks with those outside their household.
-
Big Tech Names Rise Above Broad Weakness: Stock Market Today
Some familiar names enjoyed solid rallies on the resolution of outstanding questions, but macro uncertainty hangs over the broader market.
-
AI Start-ups Are Rolling in Cash
The Kiplinger Letter Investors are plowing record sums of money into artificial intelligence start-ups. Even as sales grow swiftly, losses are piling up for AI firms.
-
What is AI Worth to the Economy?
The Letter Spending on AI is already boosting GDP, but will the massive outlays being poured into the technology deliver faster economic growth in the long run?
-
Kiplinger Special Report: Business Costs for 2026
Economic Forecasts Fresh forecasts for 2026, to help you plan ahead and prepare a budget on a range of business costs, from Kiplinger's Letters team.
-
Trump-Era Regulations Will Broaden Access to Crypto
The Kiplinger Letter The president wants to make the U.S. the leader in digital assets.
-
How to Adopt AI and Keep Employees Happy
The Kiplinger Letter As business adoption of AI picks up, employee morale could take a hit. But there are ways to avoid an AI backlash.
-
The Rise of AI: A Kiplinger Special Report
The Kiplinger Letter Our special report looks at the opportunities and challenges of generative AI and how its rapid move into the mainstream is impacting every aspect of our lives.
-
Big Changes Are Ahead for Higher Ed
The Kiplinger Letter A major reform of higher ed is underway. Colleges are bracing for abrupt change, financial headwinds and uncertainty.
-
AI-Powered Smart Glasses Set to Make a Bigger Splash
The Kiplinger Letter Meta leads the way with its sleek, fashionable smart glasses, but Apple reportedly plans to join the fray by late 2026. Improved AI will lure more customers.