Are you minimizing the amount of employment taxes your organization pays during a downsize?
Unfortunately, the consensus among economists is that the United States is due for another recession in the near-term. Although they can't pinpoint the extent and exact timing of such an event, when it does happen, this can drive workforce reductions. When downsizing, employers often offer separated employees some form of severance pay to mitigate the financial impact to them or to reward them for their years of service. However, severance payments can be associated with significant employment tax outcomes. This is especially true if the employers is contemplating a large workforce reduction. One way to reduce this tax is to establish a Supplemental Unemployment Benefits Plan or “SUB Plan.”
What is a SUB Plan?
SUB Plans are designed primarily to supplement state unemployment insurance (“SUI”) benefits. Because of this relationship to SUI benefits, most SUB Plans pay weekly benefits to eligible workers after they have been laid-off. In addition to the weekly SUI benefits, SUB Plans may ease the financial burden on workers who are laid off by providing one or more of the following benefits (all of which must be subordinate to cash benefits)1:
Health insurance coverage
How do employees qualify for SUB Plan Benefits?
Employers pay SUB Plan benefits to employees to help compensate them for involuntary separations from employment. To qualify for such benefits, the employee must be eligible for SUI benefits, and the unemployment must be the result of a “separation” that was “involuntary” for the employee.
The term “separation” includes both temporary separations, permanent severance of employment, and reductions from full-time to part-time work. In addition, an employee may be separated from employment even though it is believed that the employee will be re-employed by the same employer.
Involuntary separation typically is a termination or layoff that results from a reduction in workforce. This could be from a plant or operation closing or layoffs from cyclical, seasonal or technological causes.2
Are SUB Plan benefits exempt from employment taxes?
The benefits paid by an employer (or a SUB Plan agent or trust) to a separated employee under a SUB Plan are subject to federal and state income tax withholding. However, they are generally not subject to FICA, FUTA or SUI3 taxation. This tax exemption applies only if the SUB Plan benefits are linked to the receipt of SUI benefits. The separated employee must be unemployed, meet the requirements necessary to receive SUI benefits, and not receive the SUB Plan benefits in a lump sum.4 It is this exemption that can convey substantial savings to the separated employee and former employer over simply paying lump sum severance payments.
What are some of the advantages of SUB Plans?
The following provides some of the potential advantages of adding a SUB Plan into your separation benefit packages:
Provides income protection. Maintain the separated employees’ pre-displacement wages, partially or fully, during the period they remain unemployed after the workforce reduction.
Inequity between employees. Traditional severance creates an inequity between employees in different states. In certain states, employees can receive severance payments and unemployment benefits concurrently. Other states won't allow separated employees to receive unemployment benefits until they exhaust the traditional severance.
Balance employer and employee needs. Balances the needs of separated employees with those of an employer undergoing a major organizational restructuring.
Design alternatives. Plan design alternatives to balance an employer’s cost-reduction goals while helping to maintain strong employee relations.
Tax efficiency. Traditional lump-sum severance is highly inefficient, costing the employer far more than is necessary.
Generate SUB Plan tax savings in three primary ways:
SUI Supplement Cash Offset. Offset (reduced) weekly SUI benefits awarded to the separated employees with payments.
Duration Cash Offset. SUB Plan payments can cease upon re-employment, which means that the employer pays less to the separated employees.
Exemption from FICA, FUTA, and SUI Taxation. Payments are classified as a benefit rather than a wage, thereby eliminating employment taxes for both the former employer and the separated employees.
A lot of thought goes into designing benefit packages and how they impact employees and your organization. Incorporate a tax-efficient alternative into an existing or newly created SUB plan. We can help. Contact us today to speak with one of our Employment Tax Services professionals to determine if a SUB Plan may be right for your organization. Equifax offers off-boarding services that help reduce not only the workflow burden on employers, but supports compliance and can lower costs. Our services include unemployment cost and claims management with employment tax and workforce consulting. No matter your organization size, we have a package that can help support your needs.
1 Rev. Rul. 70-188, 1970-1 CB 133.
2 IRC §501(c)(17) and IRS Reg. §1.501(c)(17)-1(b)(3).
3 Each state has its own set of requirements for SUB Plans to qualify an employer for exemption from SUI taxation.
4 Rev. Rul. 90-72, 1990-2 CB 211; IRS Letter Ruling 9523023, March 13, 1995.