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How to Calculate Severance Pay

 

Although there is no legal requirement to offer severance, many companies provide it to employees after their employment is terminated. In general, severance pay is based on length of employment. You may decide to offer a week's pay for every year of service, or a flat amount based on six weeks' pay. When provided, it's given either as a lump sum or paid over a number of weeks.

Often included is a continuation of benefits coverage, especially health insurance.

If you'd like some yardstick to measure your ideas against others' practices, take a look at this:

  • Approximately 60 percent of businesses have formal severance plans.
  • Severance packages offer some breathing room for the unexpected loss of a job by providing a paycheck and, potentially, other benefits.
  • To get the package, employees often will need to sign paperwork that states they won't speak negatively about the company or pursue legal action. It may involve a noncompete agreement, although these can be difficult to enforce.
  • If severance is not specifically detailed in collective bargaining agreements, then the company is under no obligation to provide severance to workers represented by a labor union.
  • Many union contracts will negotiate a severance benefit for an hourly employee to get one week of pay for each year of service for a maximum of 26 weeks.
  • The typical executive benefit will be in the six-to-12-month range.
  • Besides salary, firms may offer outplacement counseling, cover health insurance and other benefits for the severance period.

What's included in formal severance pay policies?

  • Purpose. The purpose is generally to provide assistance to employees while they seek other employment.
  • When severance will—and will not—be paid. Severance policies lay out circumstances when severance will be paid, such as involuntary termination and layoffs, and when it will not be paid, such as termination for cause. You may want to set a minimum time frame for employment before an employee becomes eligible.
  • Groups covered by policy. Sometimes, the policy limits certain classes of workers; salaried workers receive it, while hourly employees don't. (But be sure you don't violate any state or federal anti-discrimination statutes.)
  • How severance pay is calculated. Will employees receive a week's salary for each year employed, or will another calculation be used? The policy may set guidelines around pay for unused vacation time, sick days and personal days.
  • Employers' rights to modify agreement. This offers protection to the employer, with the exclusive right to amend or terminate the severance policy. At the same time, severance policy may stipulate that if the company is sold or merged, severance will not be paid unless the employee is involuntarily terminated.

Also, be sure to let your employees know that if they receive income from a severance package, they may not be eligible to immediately receive unemployment benefits. Severance packages are also subject to income tax.

Finally, keep in mind that severance packages are not limited to money. Indeed, it may make sense for both the company and the employee to offer other items:

  • Positive letters of recommendation.
  • Moving expenses.
  • The company-provided laptop or cell phone the employee was using.

Research if severance is commonly included in employment contracts in your industry. Give us a call if you'd like some additional insights into assembling a severance policy.

 

 
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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