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What Employers Need to Consider About Severance Pay

Some businesses considering a reduction in force choose to offer severance pay. Here's a closer look at what business owners and HR managers need to consider.
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When employees lose their jobs through no fault of their own (e.g. layoffs or reductions in force), companies are left to settle a number of different issues at the time of separation, such as reclaiming company property and ensuring all of the appropriate documentation is signed and applicable notices are provided. Some employers choose to offer severance pay. Here's a closer look at what employers need to consider.

Are private employers required to offer severance pay?

At both the state and federal level, severance pay is generally treated as an agreement between employer and employee. There is no federal mandate that businesses offer severance pay to their former employees. For example, the Fair Labor Standards Act (FLSA) makes no provisions that require severance pay. Although there are some state mandates for severance pay applicable to the closure of a plant or business, most private employers are not mandated to offer severance pay.

Is severance pay required in any specific instance?

Severance pay may be required where employees have an employment contract or union agreement in place that provides for severance upon termination. Severance pay may also be required for public employers and for employers closing a business. Businesses may wish to consult with an expert who is knowledgeable in the law and their unique business situation to determine their potential obligations.

Who is eligible for severance?

Provided your company offers severance pay, it's typically available to employees who are let go through no fault of their own. Examples of this might include employees who are terminated as a result of mergers, acquisitions, and changes in business needs. Severance is not typically paid to employees who are fired with cause, or who leave voluntarily.

What is a severance pay contingency agreement?

In many cases, severance pay offered to employees is contingent upon signing a termination agreement. These agreements often contain clauses related to non-disparagement and an agreement not to litigate against the company (sometimes called Waiver and Release Agreements). Before creating a severance pay contingency agreement, it's important to understand whether the state where your business operates has laws that govern its content. Employers generally consult with legal counsel to draft such agreements.

Is severance pay taxable?

Previously, severance pay was considered a gray area with regard to taxes. As a result of the U.S. Supreme Court ruling in the case of US vs. Quality Stores Inc., it was determined that severance pay is taxable under FICA.

How is severance pay determined?

Several factors are commonly taken into account when creating a severance package or severance policy. Issues typically include the employee's salary level and length of service. Many employers provide an average of one-to-two weeks’ of salary for each year of service.

It's important that companies have a clear policy in place regarding severance pay, and that all applicable laws and contractual commitments are taken into account when framing severance offers. Consult with an employment attorney to review your overall organizational approach to this issue, as well as each individual case.

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