A severance agreement is a lump sum of money that’s paid out to an employee when a company terminates them. What sets severance pay apart from normal wages is that an employee doesn’t receive it because of the work that they have performed. Instead, it’s a sum that’s paid out based on a legal agreement into which the employee has entered. In some cases, the severance pay may be paid out in a large lump sum. In other cases, it may be paid in installments. While it may be disagreeable to continue dealing with the company who terminated you, getting paid in installments does have certain advantages.
Taxes on Severance Pay
As with all other forms of income, severance pay is subject to taxes. If the severance package is large enough and paid in a lump sum, it may end up being taxed more heavily. This happens because the IRS assumes that you make that amount for each pay period and as a result you should have a higher amount withheld. If your employer pays you in installments instead, you may pay less immediate taxes. In the end the taxes all even out and you will end up paying the same no matter what. However, the problem with the lump sum is that if you’re fired in January and you pay a higher tax rate on the amount, it will be a long time before you see a refund.
Severance pay is taxed in the same fashion as wages, so you’ll pay social security, Medicare, federal and state taxes. Further, if your severance package is large enough, you may need to pay additional taxes based on Section 409A of the tax code. These taxes are harsh and you can expect to pay heavily if subject to them. However, the good news is that they typically only affect higher wage earners. Most employees and lower rank managers, will not be subject to them. If you’re unsure about what tax bracket your severance package will be subject to, you should consult a tax professional.
Why Employers Offer Severance Packages
There are several reasons that employers offer their employees a severance package. People who tend to see the glass as half full might suggest that it’s because the company cares about all employees wellbeing, fired or not, and wants to give them every possible chance to find a new job without having to worry about paying the bills. While this may be true in some cases, the typical reason that a company offers a severance package is practicality.
Offering a severance package is an easy way to sever the relationship between a company and an individual, without the company having to worry about a lawsuit. When a person signs a document agreeing to the terms of the severance package, they’re also agreeing that they won’t sue the company for being fired. This makes it easy for the company to let someone go because they know exactly how much it will cost them and that they won’t have to face any potentially expensive lawsuits.
The Benefits of a Severance Agreement
For you, the employee, the major advantage of a severance package is that you’ll have the security of knowing that if you’re terminated from your job you’re guaranteed a certain amount of money which will tide you over until you find somewhere else to work. Since the sum is agreed upon you’ll be able to plan accordingly for the eventuality. This can take the stress out of losing your job and ensure that all of the bills get paid on time.
In some instances, a severance package may also give you more job security. Typically, the amount of your severance package is determined by how long you’ve been working at the company. If you’ve been working a number of years and your severance package is high, the company may choose to retain you versus another employee who doesn’t have a severance package. However, the amount of your severance package can vary depending on the situation and you should check with your employer to find out how they handle packages.
Disadvantages of a Severance Agreement
The main disadvantage of a severance package is that once you’ve signed the document you’ve forfeited all rights to sue the company in the event of your termination. So even if you get fired under questionable circumstances or you believe that your termination is entirely unjustified, there’s little legal recourse that you’ll be able to take.
In some cases, at the time of severance, you may be able to negotiate a higher severance pay package, thereby increasing your benefits. However, this depends entirely on the company that you’re working for and isn’t guaranteed. Typically, this only happens at companies that don’t have clear guidelines for issuing severance pay, and those companies that are not laying off anyone else at the same time as you.
Another disadvantage of a severance agreement is that it stops you from receiving any benefits from a EEOC discrimination claim. If you feel that you’ve been discriminated against in your dismissal you can file, the EEOC claim but you won’t be eligible to receive any benefits from it. Thus you may choose to file it because you want to protect other people from encountering the same situation, but you yourself won’t be entitled to any compensation.
Severance Packages and Unemployment
You should be aware that severance pay can have an effect on your ability to file for unemployment. In some cases, you may be able to negotiate with your employer and get them to agree to not put up much of a fight when it comes to the unemployment claim. However, what you obviously can’t get an employer to do is agree to lie. Even though this is obvious, the question has been asked before by people who are looking for the best possible chance of receiving unemployment benefits. In most cases it pays to be aware that receiving a severance package may delay or even prevent you from receiving unemployment benefits.