Severance Pay Plan Chapter 33 Employee Benefit Retirement

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning What is it? An agreement between employer and employee to make payments after the employee’s termination of employment If avoid characterization as ERISA pension plan, severance arrangements can be flexible and arranged on an individual or group basis, as needed Copyright 2009, The National Underwriter Company 1

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning Tax Implications severance payments are tax deductible to employer IF – payments are compensation for services previously rendered to employer – payment amounts are reasonable Copyright 2009, The National Underwriter Company 2

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning Tax Implications Unfunded severance pay plan severance payments are taxable to recipient as compensation income in year actually or constructively received Funded severance pay plan value of benefit is taxable to employee in first year in which employee no longer has substantial risk of forfeiture Copyright 2009, The National Underwriter Company 3

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning Tax Implications If severance pay is characterized as “parachute payment” – the employer’s deduction may be limited – the employee may be subject to penalty Tax consequences of severance pay plan generally are like those of nonqualified deferred compensation plan except for Social Security tax Copyright 2009, The National Underwriter Company 4

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning Tax Implications IRC – severance pay in general is NOT SUBJECT to special timing rule for nonqualified deferred compensation that states any amount deferred shall be taken into account for FICA purposes the latter of – when services performed – when substantial risk of forfeiture no longer exists Copyright 2009, The National Underwriter Company 5

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning ERISA Implications Dept. of Labor – severance pay plan will not be considered a “pension plan” under ERISA IF – – – payments are not contingent, directly or indirectly, on retirement total payments < twice employee compensation for year immediately preceding termination of employment all payments complete within 24 months after termination of employment Copyright 2009, The National Underwriter Company 6

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning True or False? 1. Severance pay plans are not flexible. 2. Failure to have a written severance pay plan can lead the IRS to conclude that the payment is a gift or a buyout. 3. In an unfunded plan, severance payments are taxable to recipient only when actually received. Copyright 2009, The National Underwriter Company 7

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning True or False? 4. Severance pay in a funded plan is taxed at the end of the first year that the plan was established. 5. A severance pay plan that does not meet the ERISA ‘pension plan’ exemption is treated as if it was a defined contribution plan. Copyright 2009, The National Underwriter Company 8

Severance Pay Plan Chapter 33 Employee Benefit & Retirement Planning Discussion Question Identify situations where a severance pay plan would be advantageous, first from the perspective of the employer and then from the perspective of the employee. What other ways, if any, might exist to accomplish the same end? Copyright 2009, The National Underwriter Company 9