Severance plans are designed to provide income to employees who are terminated, laid off or voluntarily quit. In contrast, a supplemental unemployment benefits (SUB) plan is designed to supplement a former employee’s state unemployment benefits after an involuntary termination.
SUB plans have tax advantages compared to severance plans but also present unique issues any employer should consider before choosing or designing a SUB plan. These include:
- Payroll tax advantages: Unlike severance plans, a SUB plan is not subject to certain payroll taxes, in particular Federal Insurance Contributions Act (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes, pursuant to Revenue Ruling 90-72. These savings can be passed on to the former employee or to the employer.
- Non-uniform eligibility: Only former employees qualifying for state unemployment benefits can qualify for SUB plan benefits. As a result, if employees live in different states with different laws, then similarly situated employees in different states (e.g., those affected by a lay-off) may not all qualify for benefits under a SUB plan.
- Voluntary terminations? Many severance plans include benefits for employees who voluntarily terminate their employment for “good reason.” In contrast, it is not clear whether voluntary terminations are permitted at all under SUB plans. As a result, it is prudent to continue to pay payroll taxes for such individuals, unless voluntary terminations are a “de minimis” benefit under a plan (i.e., less than 1 percent of total annual benefit payments).
- Benefits: SUB benefits cannot be paid in a lump sum. Instead, they must be paid periodically only as a person continues to qualify for state unemployment compensation. SUB plans also typically offset the amount of unemployment benefits paid by the state, so that a plan only pays the remainder necessary to restore the participant to his or her pre-termination pay (or a certain percentage thereof).
- Duration: When a person no longer qualifies for state benefits, he or she no longer qualifies for SUB plan benefits as well. However, SUB plans are permitted (but not required) to continue to pay benefits to individuals who exceed the maximum duration of benefits under state law, so long as such individuals remain otherwise eligible for state benefits.
- Federal law: Most SUB plans will qualify as welfare plans under the Employee Retirement Income Security Act of 1974 (ERISA), as opposed to pension plans. In contrast, a careful analysis will be needed to determine how to design a SUB plan to either comply with, or to meet an exception to, the requirements for nonqualified deferred compensation plans under Sections 409A and 457(f) of the Tax Code. These provisions may have significant tax consequences that affect the appeal of a SUB plan.
- Funding: A SUB plan does not have to be funded. Benefits can be paid out of an employer’s general assets. However, employer and/or employee contributions could be made into a SUB trust under Code § 501(c)(17). If a SUB trust is used, additional requirements will have to be met, such as prohibiting discrimination in favor of officers, supervisors or highly compensated employees with respect to eligibility and benefits.
- Administration: A SUB plan will likely require significantly greater administration than a severance plan. Participants will have to prove they are entitled to state unemployment compensation, both initially and periodically thereafter to remain eligible for benefits under a SUB plan and, potentially, to determine the proper amount of benefits.