Severance Pay

[30Rock]

How is severance pay handled under 415 regulations and for purposes of plan compensation if it is paid before the employee officially terminates? I have recently seen a pre-approved document that allows severance pay if paid prior to the time the employee terminates, for example on his last day, CAN be included unless the plan excludes it?

I was under the impression that ANY severance pay was not plan compensation eligible?

Any thoughts!

[K2retire]

Any thoughts!

The 415 regulations that were supposed to make this clearer did the opposite. (Sorry I couldn't be helpful.)

[30Rock]

^{So is it up to practitioner discretion?}

[ETA Consulting LLC]

No. Let's dissect this.

We must not confuse post-severance pay with severance pay. Post-Severance pay represents amounts that would've been paid had the employee continued to work. This type of pay is based on timing with respect to severance from employment (e.g. later of 2-1/2 months after severance or the year end). This amount "may" or "may not" be included in 415 Comp; determined by the timing.

Severance pay represents amounts that would not have been paid had the employee continued to work. These are amounts that are paid because of severance; not because of work or accrued vacation. This amount is "never" included in 415.

Good Luck!

[Kevin C]

1.415©-2 defines Section 415 compensation. In (b), there is a list of items that are included.

(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©.

As ETK mentions, severance pay isn't payment for services actually rendered, so I don't see it being counted as Section 415© compensation regardless of when it is paid.

Plan Compensation is another issue. You are not required to use Section 415 compensation or even a compensation definition that satisfies Section 414(s) to determine benefits. See 1.414(s)-1(a)(2).

[30Rock]

Well that was not my question - I understand only too well the 415 post severance rules. I am talking specifically about payment to leave the company where the company says please leave, we no longer want your services and here is $80,000 of severance pay on your last day of employment along with your final regular paycheck. Now can they defer on this $80,000 severance pay and include it in ADP testing, and receive match and nonelective? It is not post severance severance pay but it is severance pay paid on the last day before they actually terminate and walk out the door!!

Any one else have comments??

[30Rock]

You first start with 415 compensation. Then you document can define plan compensation - however you could never include in plan compensation what is not allowed as 415 compensation. So I do not think you really answered the question either.

[ETA Consulting LLC]

Wow.

So, sarcasm aside, your position is that you may have plan compensation that includes amounts that are not included in Section 415 Comp? I'm really trying to get where you are right now.

Good Luck!

[30Rock]

The original question is - is severance pay paid before an employee's termination date included in 415 compensation? I have seen a pre-approved document take this position, and then exclude this pre-termination of employment severance pay from plan compensation.

[K2retire]

Was this $80,000 payment for services rendered? Looking at the quoted reg above, I believe that is where the answer lies -- not the timing of the payment.

[Kevin C]

The original question is - is severance pay paid before an employee's termination date included in 415 compensation?

NO

As for Plan Compensation, if you think there is a requirement that plan compensation start with Section 415 compensation, please give us a cite.

[ETA Consulting LLC]

Better yet, show me Compensation that you can benefit on that is not included in Section 415. When you ask me to prove to you that an apple is a fruit, my approach would be to ask you to prove to me that it is not.

We established that the $80,000 payment:

1) was not for services rendered

2) Would not have been paid to the employee had he remained employed.

Therefore, this amount was not included in Section 415 Compensation.

You are saying he can benefit on this amount?

Show me plan language that would suggest he can. Honestly, I'm under the impression that 'Includable Compensation' in a plan starts with Section 415 and then excludes amounts such as overtime and bonuses.

Good Luck!

[30Rock]

I can show you a pre-approved volume submitter where you have to exclude severance pay if paid before termination of employment, and if you do not exclude it in the plan, then it is plan compensation. I was very surprised to see this. I think the original statement from K2 Retire said the IRS messed it up. I see another plan document that excludes severance pay on a "post severance" basis.

[Belgarath]

FWIW - interesting question.

Seems to me that the 415 regs defining what types of POST-severance pay are included or includible aren't the issue here.

As to severance payments made prior to termination of employment, I believe the plan can define compensation to include these or not, although I haven't given any thought to the practical consequences. I think there is some support for this in the following regulation - I didn't include the whole thing, but see the final paragraph of the excerpt:

§31.3401(a)-1 Wages.

(a) In general. (1) The term “wages” means all remuneration for services performed by an employee for his employer unless specifically excepted under section 3401(a) or excepted under section 3402(e).

(2) The name by which the remuneration for services is designated is immaterial. Thus, salaries, fees, bonuses, commissions on sales or on insurance premiums, pensions, and retired pay are wages within the meaning of the statute if paid as compensation for services performed by the employee for his employer.

(3) The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes wages. Thus, it may be paid on the basis of piecework, or a percentage of profits; and may be paid hourly, daily, weekly, monthly, or annually.

(4) Generally the medium in which remuneration is paid is also immaterial. It may be paid in cash or in something other than cash, as for example, stocks, bonds, or other forms of property. (See, however, §31.3401(a)(11)-1, relating to the exclusion from wages of remuneration paid in any medium other than cash for services not in the course of the employer's trade or business, and §31.3401(a)(16)-1, relating to the exclusion from wages of tips paid in any medium other than cash.) If services are paid for in a medium other than cash, the fair market value of the thing taken in payment is the amount to be included as wages. If the services were rendered at a stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the fair value of the remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the employee, the amount of such remuneration is the fair market value of the stock at the time of the transfer.

(5) Remuneration for services, unless such remuneration is specifically excepted by the statute, constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services were performed and the individual who performed them.

Example. A is employed by R during the month of January 1955 and is entitled to receive remuneration of $100 for the services performed for R, the employer, during the month. A leaves the employ of R at the close of business on January 31, 1955. On February 15, 1955 (when A is no longer an employee of R), R pays A the remuneration of $100 which was earned for the services performed in January. The $100 is wages within the meaning of the statute.

(b) Certain specific items—(1) Pensions and retirement pay. (i) In general, pensions and retired pay are wages subject to withholding. However, no withholding is required with respect to amounts paid to an employee upon retirement which are taxable as annuities under the provisions of section 72 or 403. So-called pensions awarded by one to whom no services have been rendered are mere gifts or gratuities and do not constitute wages. Those payments of pensions or other benefits by the Federal Government under title 38 of the United States Code which are excluded from gross income are not wages subject to withholding.

(ii) Amounts received as retirement pay for service in the Armed Forces of the United States, the Coast and Geodetic Survey, or the Public Health Service or as a disability annuity paid under the provisions of section 831 of the Foreign Service Act of 1946, as amended (22) U.S.C. 1081; 60 Stat. 1021), are subject to withholding unless such pay or disability annuity is excluded from gross income under section 104(a)(4), or is taxable as an annuity under the provisions of section 72. Where such retirement pay or disability annuity (not excluded from gross income under section 104(a)(4) and not taxable as an annuity under the provisions of section 72) is paid to a nonresident alien individual, withholding is required only in the case of such amounts paid to a nonresident alien individual who is a resident of Puerto Rico.

(2) Traveling and other expenses. Amounts paid specifically—either as advances or reimbursements—for traveling or other bona fide ordinary and necessary expenses incurred or reasonably expected to be incurred in the business of the employer are not wages and are not subject to withholding. Traveling and other reimbursed expenses must be identified either by making a separate payment or by specifically indicating the separate amounts where both wages and expense allowances are combined in a single payment. For amounts that are received by an employee on or after July 1, 1990, with respect to expenses paid or incurred on or after July 1, 1990, see §31.3401 (a)-4.

(3) Vacation allowances. Amounts of so-called “vacation allowances” paid to an employee constitute wages. Thus, the salary of an employee on vacation, paid notwithstanding his absence from work, constitutes wages.

(4) Dismissal payments. Any payments made by an employer to an employee on account of dismissal, that is, involuntary separation from the service of the employer, constitute wages regardless of whether the employer is legally bound by contract, statute, or otherwise to make such payments.

[30Rock]

Thank you for this cite and finding Dismissal payments. I think it is a gray area!