Severance pay is a form of temporary compensation and may also include continued benefits or other perks. It is offered by employers to employees who are being let go, typically as part of a formal separation agreement.
A Closer Look at Severance Compensation
Severance arrangements are usually governed by a company policy or outlined within an employment contract. These policies should specify which types of terminations qualify, how and when payments will be issued, and any conditions the employee must meet to be eligible, such as signing a release or adhering to confidentiality terms.
When an employee is terminated, the severance agreement should clearly define the payout amount, the payment method (lump sum or installments), and any ongoing obligations. This agreement is often finalized during the exit interview process. Having a written severance agreement ensures expectations are clear for both parties and helps reduce misunderstandings later.
While companies are not legally obligated to offer severance, some choose to extend this benefit even in cases of performance-related terminations or policy violations. The decision, and structure, of severance pay is entirely up to the employer.
Is Severance Pay Taxable?
Yes. The IRS classifies severance pay as taxable income, and it’s generally subject to the same tax withholdings as an employee’s regular wages, including federal income tax, Social Security, and Medicare.
Employers using platforms like Beyond can process severance pay through payroll systems that handle the necessary tax calculations and ensure proper reporting. It’s also critical to remember that payroll records for former employees must still be retained in compliance with IRS guidelines.
Why Do Employers Provide Severance Pay?
Severance pay is often offered to maintain goodwill with the departing employee and demonstrate appreciation for their service, particularly when the departure is due to downsizing, restructuring, or business changes, rather than individual performance issues. It can also help boost morale among remaining team members and protect the employer’s brand.
Beyond reputation management, severance agreements can serve as a legal safeguard. They often include provisions such as non-disclosure clauses, non-disparagement terms, or waivers of future claims. In this way, severance can help reduce legal risks tied to termination disputes.
Is Severance Pay Legally Required?
There’s no federal law under the Fair Labor Standards Act (FLSA) that mandates severance pay. However, if a company has an established policy, such as one included in an employee handbook or contract, it is expected to follow through. Failing to do so could expose the business to legal challenges.