Severance Payments Made to Terminated Employees Are Taxable Wages, Supreme Court Rules

May 31, 2014 | Appeals | Employment & Labor | Insurance Coverage

Before and after voluntarily entering bankruptcy, Quality Stores, Inc., an agricultural-specialty retailer, terminated thousands of employees. The employees received severance payments that were the result of a reduction in work force or a discontinuance of a plant or operation pursuant to two different termination plans.

Under the first plan, terminated employees received severance pay based on job grade and management level. The president and chief executive officer received 18 months of severance pay, senior managers received 12 months of severance pay, and other employees received one week of severance pay for each year of service.

The second plan was designed to facilitate Quality Stores’ post-bankruptcy operations and encourage employees to put off their job searches. To receive severance pay under this plan, employees had to complete their last day of service as determined by the company. Officers received between six and 12 months of severance pay, and full time employees and employees paid by the hour received one week of severance pay for every year of service if the employees had been employed for at least two years, up to a stated maximum of severance pay. Workers who had been employed for less than two years received a week of severance pay.

Quality Stores reported the severance payments as wages on W-2 tax forms, paid the employer’s required share of Federal Insurance Contributions Act (FICA) taxes, and withheld the employees’ share of FICA taxes. Then, Quality Stores asked 3,100 former employees to allow it to file FICA tax refund claims for them. About 1,850 former employees agreed to allow Quality Stores to pursue FICA refunds. On its own behalf and on behalf of the former employees, Quality Stores filed for a refund of $1,000,125 in FICA taxes.

Quality Stores brought a proceeding in the bankruptcy court seeking a refund of that amount. The bankruptcy court granted summary judgment in its favor. The district court and US Court of Appeals for the Sixth Circuit affirmed, concluding that severance payments were not “wages” under FICA.

Because other courts of appeals had concluded that at least some severance payments constituted wages subject to FICA tax, the federal government asked the US Supreme Court to review the Sixth Circuit’s decision.

The Supreme Court agreed to do so, and now has ruled that severance payments made to employees terminated against their will were taxable wages for purposes of FICA.

In its decision, the Court explained that FICA defined “wages” as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” Moreover, the Court continued, the term “employment” encompassed “any service, of whatever nature, performed … by an employee for the person employing him.” 

Under this definition, the Court stated, severance payments made to terminated employees were “remuneration for employment” because severance payments were made to employees only. Severance payments were made “in consideration for employment,” the Court added, for a “service … performed” by “an employee for the person employing him,” which was consistent with FICA’s definition of the term “employment.” 

The Court concluded by declaring that the severance payments in this case were made to employees terminated against their will, were varied based on job seniority and time served, and were not linked to the receipt of state unemployment benefits. Under FICA’s broad definition, it concluded, these severance payments “constituted taxable wages.” [United States v. Quality Stores, Inc., 2014 U.S. Lexis 2213 (March 25, 2014).]

Ex-Employee’s Worker’s Compensation Retaliation Lawsuit Fails Where He Was Terminated for Refusing to Take a Mandatory Drug Test

The plaintiff in this case worked as a passenger general trucker at the Continental Tire The Americas, LLC, tire manufacturing facility in Mt. Vernon, Illinois. When he visited the facility’s health services department to report that his fingers had gotten numb at work and to initiate a worker’s compensation claim, he was informed that he had to submit to a drug test before he could initiate the claim pursuant to the company’s drug testing policy. He also was advised that if he did not take the drug test, his employment would be terminated. The plaintiff refused to take the drug test because he did not think that it should be a necessary consequence of filing a worker’s compensation claim, and he was fired.

The plaintiff filed a claim for worker’s compensation benefits and eventually received them. He nevertheless sued the company, alleging that it had retaliated against him for seeking worker’s compensation benefits in violation of Illinois law.

The district court granted the company’s motion for summary judgment, and the plaintiff appealed to the US Court of Appeals for the Seventh Circuit.

The circuit court affirmed.  In its decision, it explained that Illinois law recognized a cause of action for retaliatory discharge where an employee was terminated because of his or her actual or anticipated exercise of worker’s compensation rights. The circuit court added that, to establish a retaliatory discharge claim, a plaintiff had to prove that he or she had been an employee before the injury; that he or she had exercised a right granted by the state’s worker’s compensation law; and that he or she had been discharged and that the discharge was causally related to the plaintiff’s pursuit of a claim under the worker’s compensation law.

The Seventh Circuit then ruled that the plaintiff in this case had not established causation, explaining that the “undisputed facts” established that company had terminated the plaintiff because he had refused to take a drug test upon initiation of his worker’s compensation claim as required by company policy. The appellate court, observing that the plaintiff had admitted that he had no evidence or other information that the company had any other reason for discharging him, found that the company consistently had applied its drug testing policy and had discharged other employees who had refused to submit to a drug test pursuant to the policy.

Therefore, the circuit court concluded, the plaintiff could not establish that his discharge had been motivated by his pursuit of a worker’s compensation claim and he could not prevail on his retaliatory discharge claim. [Phillips v. Continental Tire the Americas, LLC, 2014 U.S. App. Lexis 2841 (7th Cir. Feb. 14, 2014).]

Arbitration Agreement Waiving Employee’s Ability to Bring FLSA Suit Is Enforceable, Circuit Court Decides

The plaintiffs in this case worked as window repairers for Chipio Windshield Repair, Kingco Promotions, Inc., and Levaughn Hall (collectively, the “Chipio defendants”). After their employment ended, the plaintiffs brought a putative collective action against the Chipio defendants, pursuant to the Fair Labor Standards Act (FLSA). Their complaint alleged that the Chipio defendants:

  1. had not paid minimum wages to them, in violation of FLSA § 6;
  2. had not compensated them for the time that they had worked in excess of 40 hours per week, in violation of FLSA § 7; and
  3. had not made adequate and accurate records of their wages and hours, in violation of FLSA §§ 11(c) and 15(a)(5).

The Chipio defendants filed a motion to compel arbitration, arguing that the plaintiffs had signed separate, identical arbitration agreements in which they had agreed that any kind of employment disagreement would be submitted to binding arbitration – and that they could bring claims only individually and not as class members.

In response, the plaintiffs contended that their right to file a collective action under the FLSA was a non-waivable, substantive right and that the arbitration agreements were invalid because they purported to waive that right.

The district court ruled in favor of the Chipio defendants and dismissed the plaintiffs’ complaint. The district court determined, among other things, that the arbitration agreements should be enforced in light of the strong policy in favor of arbitration under the Federal Arbitration Act (FAA). The plaintiffs appealed to the US Court of Appeals for the Eleventh Circuit.

The circuit court affirmed the district court’s ruling. In the circuit court’s decision, it first explained that the FAA embodied a “liberal federal policy favoring arbitration agreements” and that the FAA sought “to relieve congestion in the courts and to provide parties with an alternative method for dispute resolution” that was “speedier and less costly than litigation.” 

The circuit court then pointed out that there was no dispute that the plaintiffs’ FLSA claims against the Chipio defendants fell within the scope of the arbitration agreements they had signed, and that the plaintiffs explicitly had waived their rights to any representative arbitration and had agreed only to individual arbitration. Thus, according to the appellate court, the FAA required enforcement of the arbitration agreements according to their terms, which, in this case, meant individual, not collective, arbitration.

In addition, the circuit court rejected the plaintiffs’ argument that the arbitration agreements were unenforceable because they contained an improper waiver of the plaintiffs’ statutory right to file a collective action under the FLSA. The circuit court concluded that there was no explicit provision in the FLSA precluding arbitration or a waiver of the right to a collective action, that there was nothing in the FLSA that overrode the FAA, and that the enforcement of collective action waivers in arbitration agreements was not inconsistent with the FLSA. [Walthour v. Chipio Windshield Repair, LLC, 2014 U.S. App. Lexis 5315 (11th Cir. March 21, 2014).]

Comment: Other circuit courts also have concluded that the FLSA does not provide for a non-waivable, substantive right to bring a collective action. See Sutherland v. Ernst & Young LLP, 726 F.3d 290 (2d Cir. 2013) (determining that the FLSA did not contain a “contrary congressional command” that prevented an employee from waiving his or her ability to proceed collectively and that the FLSA collective action right was a waivable procedural mechanism); Owen v. Bristol Care, Inc., 702 F.3d 1050 (8th Cir. 2013) (determining that the FLSA did not set forth a “contrary congressional command” showing “that a right to engage in class actions overrides the mandate of the FAA in favor of arbitration”); Carter v. Countrywide Credit Indus., Inc., 362 F.3d 294 (5th Cir. 2004) (rejecting the plaintiffs’ claim that their inability to proceed collectively deprived them of a substantive right to proceed under the FLSA); Adkins v. Labor Ready, Inc., 303 F.3d 496 (4th Cir. 2002) (determining that plaintiff failed to point to any “suggestion in the text, legislative history, or purpose of the FLSA that Congress intended to confer a non-waivable right to a class action under that statute” and that the plaintiff’s “inability to bring a class action, therefore, cannot by itself suffice to defeat the strong congressional preference for an arbitral forum”). 

Court Rejects Employer’s Requirement that Employees on Intermittent FMLA Leave Provide a Doctor’s Note for Each Absence

Believing that a few employees seemed to be disproportionately taking time off on Mondays and Fridays, or just before a holiday, Oak Harbor Freight Lines, Inc. developed a policy that required a note from a medical provider for employees taking intermittent Family and Medical Leave Act (FMLA) leave.

One employee who began working for Oak Harbor in 2006 used FMLA leave in 2008. He requested leave again beginning in November 2010 for lumbar radicular pain and spondylolisthesis; the certification indicated the employee’s need for intermittent leave and part-time leave, noting ongoing monthly office visits. The employee received approval for intermittent leave again in 2011 for his daughter’s serious health condition and again in 2012 for his own medical condition.

The employee had treatment scheduled on Fridays during the summer of 2012; he offered to provide at least one week advance notice of the appointments, but Oak Harbor insisted on a doctor’s note as well. The employee provided notes from a physician’s assistant on some occasions, and the company accepted them. On other occasions, he did not submit a note and Oak Harbor put the employee on indefinite suspension.

Another employee, who had begun working for Oak Harbor in the early 1990s, was diagnosed with a peptic ulcer and gastrointestinal bleeding in January 2008 and was approved for intermittent leave beginning in February 2008. He received three verbal warnings, five written warnings, seven notices of intent to suspend, seven notices of suspension, and three notices of intent to terminate because he failed to provide a medical provider’s note to Oak Harbor.

Oak Harbor went to court, seeking a court ruling that it could require employees who had been approved for intermittent leave to submit a short note from their medical provider that stated that the absence of the employee was related to the family leave qualifying condition upon which intermittent leave had been granted. In response, the employees argued that Oak Harbor had no statutory or regulatory authority to require its employees taking approved intermittent leave to get a doctor’s note for each absence.

The court agreed with the employees and ruled that Oak Harbor’s requirement that its employees on intermittent leave provide a doctor’s note for each absence was tantamount to requesting a medical certification for each absence.

In its decision, the court noted that although an employer may require that a leave request “be supported by a certification issued by the health care provider of the eligible employee, … if an employee submits a complete and sufficient certification signed by the health care provider, the employer may not request additional information from the health care provider.”

The court then explained that although both the FMLA and the federal regulations that implemented the law were silent on the specific issue of whether Oak Harbor’s doctor’s note policy to support an already medically certified FMLA-protected absence was permissible, the statute and regulations showed “an intent to limit medical verification to certification and recertification as delineated.” In other words, the court declared, neither the FMLA nor its regulations provided for any additional means by which an employer could require documentation from an employee’s medical provider.

The court observed that certain court decisions stood for the proposition that an employer could require its employees to notify it of their status and intent to return to work, adding that these kinds of policies were contemplated by the FMLA and regulations. It also acknowledged that intermittent leave could impose an administrative and tracking burden. The court ruled, however, that if Oak Harbor’s concern were leave abuse, the recertification process provided under the FMLA protected it; its doctor’s note policy, untethered to the statutory and regulatory limitations on requesting such recertifications, violated the law. [Oak Harbor Freight Lines, Inc. v. Antti, 2014 U.S. Dist. Lexis 20203 (D. Ore. Feb. 19, 2014).]

Circuit Court Affirms Decision Against Plaintiff Who Rejected FMLA Leave, Took Time, and Then Was Fired for Violating Company’s “No-Show” Policy

The plaintiff in this case worked in a Foster Poultry Farms, Inc., processing plant in Turlock, California. She was terminated for failing to comply with the company’s “three day no-show, no-call rule” after she had come to the end of a previously approved period of leave, which she had taken to care for her ailing father in Guatemala.

On November 23, 2007, the plaintiff, having obtained two weeks vacation time, traveled to Guatamala to care for her father. She did not return within the two week period and did not communicate with anyone affiliated with Foster Farms until December 21, 2007.  At that time, the plaintiff was advised that she would be automatically terminated because she had been absent for three work days without notifying the company or without seeking a leave of absence.

The plaintiff subsequently sued Foster Farms, contending that it had violated the Family and Medical Leave Act (FMLA). She asserted that her termination was an unlawful interference with her rights under the FMLA. For its part, Foster Farms contended that although the plaintiff had provided an FMLA-qualifying reason for taking leave, she explicitly had declined to have her time off count as FMLA leave.

A trial was held and the jury ruled in favor of Foster Farms. The plaintiff appealed.

The US Court of Appeals for the Ninth Circuit affirmed. In its decision, it rejected the plaintiff’s argument that Foster Farms should have designated her leave as FMLA-protected regardless of whether she expressly had declined such a designation. The circuit court found “substantial evidence” that the plaintiff had elected not to take FMLA leave.

It then noted that Foster Farms had introduced evidence explaining why the plaintiff might have declined to take FMLA leave at the time. The circuit court pointed out that, under the company’s policies, FMLA leave ran concurrently against the balance of both an employee’s accrued vacation time and the employee’s FMLA-protected leave until the paid vacation time was exhausted. Thus, when an employee’s paid vacation time expired, that employee could remain on unpaid leave until a total of 12 weeks had elapsed. However, the circuit court continued, a different result occurred if an employee initially declined FMLA leave because, by declining to take FMLA leave and subsequently requesting it at a later date, an employee first could take paid vacation, after which that employee still would have the full 12 weeks of FMLA leave remaining.

In other words, the circuit court explained, in this case, if the plaintiff purposefully had deferred asking for FMLA leave until after the expiration of her paid leave, she would have had two more weeks of protected leave than if she initially had requested family leave. In addition, Foster Farms submitted evidence that the plaintiff had requested FMLA leave 15 times previously, showing that the plaintiff knew how to request it had she wanted to.

The circuit court concluded, therefore, that the jury had ample evidence to render a verdict against the plaintiff due to her noncompliance with Foster Farms’ “three day no-show, no-call rule.” [Escriba v. Foster Poultry Farms, Inc., 2014 U.S. App. Lexis 3571 (9th Cir. Feb. 25, 2014).]

Ex-Employee Loses $80,000 from Settlement After Daughter’s Facebook Post

After Gulliver Schools, Inc., did not renew its headmaster’s contract, he sued the school, alleging age discrimination and retaliation under the Florida Civil Rights Act. The parties reached a settlement agreement providing for the full and final settlement of the plaintiff’s claims, with the school to pay $10,000 in back pay to him with “Check # 1,” $80,000 as a “1099” with “Check #2,” and $60,000 to his attorneys with “Check # 3.”

The settlement agreement included a detailed confidentiality provision that provided that the existence and terms of the agreement between the plaintiff and the school were to be kept strictly confidential and that should the plaintiff or his wife breach the confidentiality provision, a portion of the settlement proceeds (the $80,000) would be disgorged.

Four days after the agreement was signed, the plaintiff’s college-age daughter posted the following on Facebook:

Mama and Papa … won the case against Gulliver. Gulliver is now officially paying for my vacation to Europe this summer. SUCK IT.

This Facebook post went out to approximately 1,200 of the daughter’s Facebook friends, many of whom were or had been Gulliver students.

Gulliver sent a letter to the plaintiff’s counsel, stating that it was tendering the attorney’s fees portion of the parties’ agreement but was not going to tender the plaintiff’s portion because he had breached the confidentiality provision. 

The plaintiff filed a motion to enforce the settlement agreement, arguing that a statement that he had made to his daughter that his case against Gulliver was settled and that he was happy with the result and her Facebook post did not constitute a breach of the confidentiality agreement. The trial court agreed with the plaintiff, and Gulliver appealed.

The appellate court reversed. The appellate court explained that the agreement between the plaintiff and the school was that neither the plaintiff nor his wife would “either directly or indirectly” disclose to anyone (other than their lawyers or other professionals) “any information” regarding the existence or the terms of the parties’ agreement.

It then found a breach of the agreement by the plaintiff’s admission that he had had a “conversation with [his] daughter” in which he had told her that the dispute with Gulliver had been settled and that he was happy with the results. It added that the fact that he said that he needed to tell his daughter something “did not excuse this breach,” observing that there was no evidence that he made this need known to the school or to his or its attorneys so that the parties could reach a mutually acceptable course of action in the agreement.  

The appellate court concluded by declaring that, “before the ink was dry on the agreement, and notwithstanding the clear language … mandating confidentiality, [the plaintiff] violated the agreement by doing exactly what he had promised not to do” and his daughter “then did precisely what the confidentiality agreement was designed to prevent, advertising to the Gulliver community that [the plaintiff] had been successful in his age discrimination and retaliation case against the school.” [Gulliver Schools, Inc. v. Snay, 2014 Fla. App. Lexis 2595 (Fla. Ct.App. Feb. 26, 2014).]

Reprinted with permission from the June 2014 issue of the Employee Benefit Plan Review – From the Courts.  All rights reserved.

Related Publications


Legal updates and news delivered to your inbox