Severance paid day before last day

[austin3515]

Let's say someone's last day is Friday, and on the day befpore (thursday) they get a check that includes a month of severance. Is it excluded or included? The money was received PRE-severance.

[david rigby]

As best I recall (don't have the reg in front of me), the 415 reg (April 2007?) includes significant discussion about whether to include comp, but the focus is only on comp received after the DOT. If that is correct, then comp received before DOT is not severance comp. (But my recollection may be incomplete.)

BTW, the reg states that DOT is an event, not gradual or phased in.

[austin3515]

Talk about a gotcha... I bet this is actually not that uncommon (though probably rare enough). Cash rich companies would rather not have to keep sending paychecks, and more importantly end the relationship, and often hand deliver the last check on the last day (especially if the last day is the day they are told!).

[Kevin C]

What compensation definition does the plan use? If it only includes the items in 1.415©-2(b), I don't see the severance as compensation regardless of when it is paid. Severance pay is paid because future services will not be performed, so it would not be an amount received for personal services actually rendered in the course of employment with the employer sponsoring the plan.

[austin3515]

Everything I see references compensation paid "after severance from employment" 1.415©-2(e)

[Kevin C]

Look closer to the top of the reg section. Does severance pay fit any of these categories?

1.415©-2(b)Items includible as compensation.—

For purposes of applying the limitations of section 415, except as otherwise provided in this section, the term compensation means remuneration for services of the following types—

(1) The employee's wages, salaries, fees for professional services, and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan, to the extent that the amounts are includible in gross income (or to the extent amounts would have been received and includible in gross income but for an election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 402(k), or 457(b)). These amounts include, but are not limited to, commissions paid to salespersons, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements or other expense allowances under a nonaccountable plan as described in §1.62-2©.

(2) In the case of an employee who is an employee within the meaning of section 401©(1) and regulations promulgated under section 401©(1), the employee's earned income (as described in section 401©(2) and regulations promulgated under section 401©(2)), plus amounts deferred at the election of the employee that would be includible in gross income but for the rules of section 402(e)(3), 402(h)(1)(B), 402(k), or 457(b).

(3) Amounts described in section 104(a)(3), 105(a), or 105(h), but only to the extent that these amounts are includible in the gross income of the employee.

(4) Amounts paid or reimbursed by the employer for moving expenses incurred by an employee, but only to the extent that at the time of the payment it is reasonable to believe that these amounts are not deductible by the employee under section 217.

(5) The value of a nonstatutory option (which is an option other than a statutory option as defined in §1.421-1(b)) granted to an employee by the employer, but only to the extent that the value of the option is includible in the gross income of the employee for the taxable year in which granted.

(6) The amount includible in the gross income of an employee upon making the election described in section 83(b).

(7) Amounts that are includible in the gross income of an employee under the rules of section 409A or section 457(f)(1)(A) or because the amounts are constructively received by the employee.

[austin3515]

Interesting... I'm a convert. It's out

[Guest Sieve]

I agree with Kevin's analysis--but why give up, austin . . . be creative. If you really want to beat the game, you could argue that such a lump-sum payment prior to termination of employment is considered a "termination bonus" for prior services actually rendered, and includible in 415 comp (and subject to deferral)--but, as an unscheduled bonus, could not be have been deferred if paid after termination of employment because it wouldn't have been paid prior to termination of employment if the employee had remained employed (Treas. Reg. Section 1.415©-2©(3)(ii)(B)).

Regardless of what it is called, the chance that such a payment made before termination of employment would NOT have a deferral taken out in the regular course of events would be slim to none, I suspect.

In any event, why would the employer want to make a lump-sum severance payment before termination of employment, especially if the employee might defer a large amount (if permitted by the plan) and receive a large match?

[austin3515]

In any event, why would the employer want to make a lump-sum severance payment before termination of employment, especially if the employee might defer a large amount (if permitted by the plan) and receive a large match?

I have the patience nor the desire to figure out why clients do what they do. The important thing is that they did

[PensionPro]

See post 6 on this string from 2000 for another way of looking at it ... "Technically, I think that it will depend on when the severance is paid. I know the IRS position is that severance is not paid to an "employee" or for services rendered "on account of employment," so it shouldn't be taken into account under a qualified retirement plan. It is an unworkable standard, so I have heard that a safe approach is to count it (assuming that the plan doesn't exclude it) if it is included in a final paycheck or received (in advance) while the person is still an employee. Once the person leaves employment, amounts paid as severance shouldn't be included in plan compensation even if the plan definition includes it because it is not being paid to employees for services rendered."

http://benefitslink.com/boards/index.php?showtopic=437

Also an article on the McKay Hochman Web site states that ... "Theoretically, pure severance pay is not payment for services rendered and should not be considered plan compensation. Often times it is a payment for the release of legal liability for terminating an employee’s services. Other times the payment is unrelated to any actual services, but is a stated amount such as $1,000. Though not our position at McKay Hochman, some industry practitioners argue that the amount can be counted if actually paid prior to or commensurate with the separation."

Everyone agrees that severance pay after date of termination is not plan compensation. However on the question whether severance pay on or before date of termination is plan compensation there seem to be interpretations both ways.

[Kevin C]

Everyone agrees that severance pay after date of termination is not plan compensation. However on the question whether severance pay on or before date of termination is plan compensation there seem to be interpretations both ways.

Not exactly. I agree that severance pay received after the date of termination is not Section 415© compensation. As mentioned above, I think severance pay is not Section 415© compensation even if paid before termination of employment. Whether or not severance pay is plan compensation will depend on what definition of plan compensation the plan uses.

[PensionPro]

Under which definition of plan compensation in your view would severance pay be includible if paid on or before term date?

3401(a) Wages means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer. So following similar logic, severance pay would not be includible under this definition since no services were performed.

Which leaves the W-2 definition ...

[Guest Sieve]

PensionPro -- See my earlier Post #8 for a way that a so-called severance payment paid prior to employment termination could be treated merely as a bonus for services rendered, and therefore included in 415 compensation (& with deferrals permitted).

Remember, though, that using a W-2 definition of compensation still does not allow deferrals to be taken from severance payments paid after termination of employment (per Treas. Reg. Section 1.401(k)-1(e)(8)).

[Kevin C]

Under which definition of plan compensation in your view would severance pay be includible if paid on or before term date?

Actually, I was thinking the plan compensation definition could be written to include severance. There is no requirement that plan compensation be based on 415©, 3401(a) or W-2. It doesn't even have to be a definition that satisfies 414(s) [see 1.414(s)-1(a)(2)]. That's why I asked what definition the plan uses. It's also possible the definition isn't clear and has to be interpreted by the ERISA Plan Administrator.

We typically use 415© as the basis for the plan compensation definition in part because the regulations language is pretty clear that severance pay doesn't count.

[PensionPro]

Under which definition of plan compensation in your view would severance pay be includible if paid on or before term date?

Actually, I was thinking the plan compensation definition could be written to include severance. There is no requirement that plan compensation be based on 415©, 3401(a) or W-2. It doesn't even have to be a definition that satisfies 414(s) [see 1.414(s)-1(a)(2)]. That's why I asked what definition the plan uses. It's also possible the definition isn't clear and has to be interpreted by the ERISA Plan Administrator.

We typically use 415© as the basis for the plan compensation definition in part because the regulations language is pretty clear that severance pay doesn't count.

Thanks for clarifying!