Sixth Circuit holds teachers' severance pay subject to FICA.

A school district in Michigan offered an early employee severance plan (ESP) to its most senior teachers who had at least 10 years of service and were at a high step in the pay scale. The ESP participants (Ps) were required to resign, and to agree to a waiver of all claims arising out of employment with the district, including claims under the Michigan Tenure Act. Additionally, Ps agreed to "waive ... all entitlement to future wage and benefit increases, all rights to participate in any district sponsored benefit plans" and agreed not to "apply for reemployment" without the school district's consent. In return, they received the equivalent of their 1999-2000 annual base salary in 60 monthly payments over a five-year period.

Two class actions were brought by Ps and consolidated on this appeal to the Sixth Circuit. One district court granted them summary judgment, holding that the severance payments were not wages within the meaning of FICA; see Tax Trends, "Teacher Severance Pay Not Subject to FICA" TTA, December 2004, p. 781. The other granted summary judgment to the IRS.

Definition of Wages

Sec. 3121(a) defines "wages" as "all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash." Employment is defined in Sec. 3121(b), as "any service, of whatever nature, performed (A) by an employee for the person employing him." Under Regs. Sec. 31.3121 (a)-1 (i), remuneration for employment, unless specifically excepted, "constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services were performed and the individual who performed them."

As explained in Regs. Sec. 31.3121 (a)-1(c), "[t]he name by which the remuneration for employment is designated is immaterial.... salaries, fees, bonuses, and commissions ... are wages if paid as compensation for employment." In Soc. Sec. Bd. v. Nierotko, 327 US 358 (1946), the Supreme Court held that back pay awarded to wrongfully discharged employees under the National Labor Relations Act constituted wages for purposes of the Social Security Act of 1935. The Sixth Circuit has followed the reasoning of Nierotko and emphasized that the phrase "remuneration for employment," as it appears in Sec. 3121, should be interpreted broadly; see Gerbec, 164 F3d 1015 (6th Cir. 1999).

Eligibility Requirements

In determining whether a payment constitutes wages, courts have looked to eligibility requirements, specifically longevity, as an important factor; see Sheet Metal Workers Local 141 Supplemental Unemployment Benefit Trust Fund, 64 F3d 245, 250 (6th Cir. 1995); Associated Elec. Coop., Inc., 226 F3d 1322, 1328 (Fed. Cir. 2000); and Abrahamsen, 228 F3d 1360 (Fed. Cir. 2000).

In this case, the severance payments were conditioned on a teacher having served a certain number of years--exceeding that of obtaining tenure under Michigan law--with the school district. Ps necessarily had to have tenure to be eligible for the buyout. However, longevity--not tenure--was the key factor in determining eligibility, because the early retirement payments were offered to encourage teachers at a high pay rate to retire. The payments at issue in this case arose out of the employment relationship and were conditioned on a minimum number of years of service.

Ps claim that they gave up their rights as tenured teachers to continued employment, absent just cause for termination. However, according to the Sixth Circuit, a court must not look simply at what is being relinquished, but rather, at how the right relinquished was earned. Thus, it emphasized the importance of the fact that a teacher earns tenure by successfully completing a probationary period. Although the grant of this right is guaranteed and protected by statute, it must still be earned through services to the employer.

Relinquishment of Contract Rights

In Rev. Rul. 58-301, 1958-1 CB 23, an employee with a five-year contract right to employment agreed to relinquish it during the second year in exchange for a lump-sum payment. The IRS concluded that payments for a relinquishment of rights under a contract are not wages under FICA. In contrast, Ps here have received their statutorily granted tenure rights after a certain requisite number of years of service. In this situation, Rev. Rul. 75-44, 1975-1 CB 15, indicates that the severance payments at issue are FICA wages. Thus, the severance payments at issue fall within the definition of FICA wages as "all remuneration for employment" under Sec. 3121(a).

DONALD F. APPOLONI, SR., 6TH CIR., 6/7/06

REFLECTIONS: The dissent indicated that it would have followed the authority of North Dakota State University, 255 F3d 599 (8th Cir. 2001).