ComplianceLegalJanuary 13, 2021

A look at severance payments

If structured properly, severance payments made to an employee who has been laid off can benefit both the employee and the employer.

The payments can give a former employee some security while searching for new work. The employer, when it rewards an employee for past service, may benefit from the resulting goodwill.

But perhaps the most important benefit, from an employer's perspective, is that a severance payment that includes a release -- a waiver of claims against the employer -- can protect the employer from suits by a former employee, according to Allan H. Weitzman of the Proskaur Rose law firm.

Several types of claims can be waived by a valid release. As a general rule, these include claims arising under the Age Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, and the Employee Retirement Income Security Act, as well as state discrimination claims.

Releases don't provide absolute protection. Generally, for example, employees cannot release their right to file a charge with the Equal Employment Opportunity Commission. Neither can they release their right to file a claim under the Fair Labor Standards Act without approval from the Department of Labor. Some states bar employers from seeking a release of an employee's right to file a workers' compensation claim. And releases generally cannot apply to future claims, such as claims that arise after the effective date of a release.

When an employer wants an employee to sign a liability release, the employer must provide the employee with some additional benefit to which the employee otherwise would not be entitled, Weitzman said. That additional benefit is referred to as "consideration" for the promise not to sue the employer, and it must be present if the release is to be valid. The courts have generally ruled that a severance payment is valid consideration for a release, since employers are not otherwise legally required to provide it. But make sure that you speak to an attorney before offering a severance package, just to make sure.

Determining the amount of a severance payment is a business decision a company will need to consider. This is especially true for small businesses, where severance payments tend to be less common not just because they can be expensive but because the very smallest businesses are, in many cases, already exempt from many of the workplace discrimination laws.

For those who do decide to offer severance packages, one of the most important factors in determining the amount is the number of years an employee has served the company, Weitzman said. Employees with several years of service ordinarily receive more money, as do high-ranking executives.

In all cases, Weitzman suggested, a company should carefully consider what it has done in the past, as well as the circumstances surrounding any current severance decision. A company generally provides larger severance payments when terminations are messy and when the company's chances of prevailing in litigation are low. Also, you need to consider whether providing severance pay to one employee who is let go will create an expectation in others that they will be entitled to a severance package if they are let go.

Employers can make severance payments in lump sums or in periodic payments. When made periodically, the payments can be paid from payroll. A company can structure periodic payments to end when the former employee secures a new job.

The tax consequences of severance payments and their effect on unemployment benefits are two other areas employers should be aware of, Weitzman said. Severance payments generally are taxable and subject to withholdings. Also, the receipt of severance payments generally does not affect a former employee's eligibility to receive unemployment benefits.

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