Severance Pay: 5 Need-to-Know Tips
On Friday, October 26th, Laura Saunders in the “Tax Report“ for the Wall Street Journal, wrote about a very important subject–severance pay. The question she discussed: Do laid-off workers and their former employers owe Social Security and Medicare taxes on severance pay? Two federal appeals courts have disagreed about the answer.
According to Saunders, typically, employees and employers each owe a flat Social Security tax of 6.2% up to a cap (currently $110,100), plus Medicare tax of 1.45% (unlimited) on wages, for a combined rate as high as 15.3%. Together these are known as ‘FICA’ or ‘pay roll taxes’. For an executive who was laid off in 2009 and received $100K of severance, the total tax could come to about $15K, split equally between the laid-off executive and his company.
With two federal appeals courts disagreeing about where severance pay is subject to payroll taxes, many experts say the issue could windup before the US Supreme Court.
For those laid-off in 2011 and 2012, the potential tax is lower since there was a temporary two-percent cut in employee’s social security. Timing of the lay-off also matters, If the lay-off occurred at a time in the year when a worker’s pay already hit the earnings cap, then only the 2.9% Medicare tax is in question.
This issue applies to severance paid for involuntary terminations for lay-offs, discontinued operations and the like. It does not come into play for firings for cause.
Some recommended tips for those laid-off include:
1. Make sure your employer continues to withhold FICA taxes on severance pay until the issue is clarified.
2. Have your employer file a refund claim for the taxes. This will preserve your right to benefit from a favorable court decision in the future.
3. Prepare to contest. If the IRS denies the refund claim, have your employer file a ‘refund action’ in the US District Court. Again this will preserve your right to benefit from a favorable decision.
4. If you former firm didn’t file a refund claim, but you believe you are entitled to one, you can file IRS form 843 to make your own claim. This must be done during the statute of limitations period–three years after the April 15th due date following the year the severance was received.
It’s your money, go for it!