Introduction

When reducing their workforces, many employers offer temporary incentives for employees to voluntarily separate from employment, including affording early retirement incentives that are available only for a limited period of time. Many employers also afford involuntarily terminated employees extra pay. The extra pay may be paid in return for agreements releasing legal claims to avoid the risk of RIF-related litigation. It may also be paid to help workers transition to new employments or simply to part ways with employees on as amicable a basis as possible. Conversely, employers or labor organizations may establish or maintain supplemental unemployment benefit plans (“SUB plan”) or early retirement incentives that are not limited or temporary in nature. The taxation of such entitlements is explained below.

Limited Plans of Termination Taxation All actual or constructive distributions of cash or property upon dismissal, termination, or severance of employment (whether by retirement or otherwise) under a limited plan of termination constitutes severance pay for personal income tax purposes. Limited Plan of Termination Explained A limited plan of termination is an employee benefit plan that has one or more of the following attributes: The plan, when begun, is scheduled to be completed by a certain date or upon the occurrence of one or more specified events. The number, percentage or class of employees whose services are to be terminated are specified in advance of the employees’ terminations of service. The plan is otherwise temporary or limited. Supplemental Unemployment Benefits (SUB Plan) Taxation Amounts paid from a supplemental unemployment benefits trust (“SUB trust”) that forms part of a permanent, nondiscriminatory SUB plan are excludible from tax. However, amounts actually or constructively paid by an employer under a temporary, limited, unfunded, or discriminatory SUB plan constitute taxable severance pay. SUB Plan Explained A SUB plan is a plan established or maintained by an employer or by an employee organization, or by both, that has all of the following attributes: No benefit is payable to, or can be taken, assigned, pledged or otherwise charged or dealt with by, any plan participant except upon lay-off or involuntary separation from the employment of the employer (whether or not the separation is temporary) resulting directly from a reduction in force, plant closing, change in organizational structure, discontinuance of an operation, the participant’s failure to meet or maintain standards of performance for the position due to inability to carry out the responsibilities of the position, health, obsolescence, failure to meet the changed responsibilities of the position or similar circumstance beyond the control of the participant. No benefit is payable to, or can be taken, assigned, pledged, or otherwise charged or dealt with by, any plan participant if the participant either voluntarily separates from service or is separated or discharged from service for any of the following reasons: Refusal to accept another position with reasonably comparable compensation. The commission of illegal acts. Insubordination, failure or refusal to comply with rules or regulations or similar acts within the control of the participant. Voluntary Discontinuance of Plan The voluntary discontinuance of a SUB plan within 3 years after it has taken effect, for any reason other than business necessity, will be evidence that the plan was temporary and limited. Early retirement enhancements General Rule Any portion of a payment that is only available for a limited period of time as an early retirement “window benefit” is taxable as severance pay. Exceptions The added benefits payable to retired persons under Federally qualified defined benefit plans that include: Adding additional years to the employee’s actual age and/or actual service to reduce or eliminate the effect of actuarial reductions in benefits on account of early retirement; Crediting additional years of service to the employee in calculating benefits under a plan’s benefit formula; Offering social security “bridge payments” to plan participants in order to increase benefits under the employer’s retirement benefit plan until they become eligible for social security benefits; or Offering subsidized joint and survivor annuities constitute excludible retirement benefits, even if offered only on a temporary or limited basis.