While the coronavirus pandemic wreaked havoc on the economy and jobs, employers considered disaster-related employee benefit structures, such as easily administered qualified disaster assistance relief programs and the financially attractive severance alternative known as "supplemental unemployment benefit plans" or "SUB-pay plans." Compared to the typical severance program, restructuring a temporary or permanent layoff program as a SUB-pay plan can yield financial and tax savings exceeding 30% of an employer's typical severance costs while also providing FICA tax savings to employees of 7.65%.

Due to the significant cost savings offered by a properly structured and operated SUB-pay plan, these should always be the first step in any analysis when an employer contemplates permanent or temporary downsizing. As contrasted to Section 139 disaster relief payments, the financial and tax attributes associated with a valid SUB-pay plan will require the advice and counsel of experienced tax and employment advisers to navigate the issues associated with SUB-pay. The severance restructuring is generally considered worth the associated efforts and this article provides important background and a roadmap to some of those issues. Once in operation, the plans can be self-administered while navigating and responding to the financial, operational, and human costs raised by the coronavirus.

Overview

Although SUB-pay plans have existed for more than half a century, most companies and advisers outside of the steel and automotive industries have little experience with these arrangements. Nevertheless, they can be adopted and implemented with relative ease on short notice in lieu of traditional severance. To achieve the dual financial savings associated with SUB-pay, existing severance structures will need to be carefully modified to conform to the various administrative, statutory, and case law nuances impacting SUB-pay plans that are highlighted in this article.

These changes are often seamless to the terminated worker. If properly drafted and operated pursuant to their terms, an employer with traditional severance costs of approximately $10 million can reduce its out-of-pocket costs by more than $3 million depending on its facts and circumstances, while its employees can receive the same net benefit payment (or more) than offered under a traditional severance.

Severance arrangements generally are drafted without any consideration for their impact on state unemployment benefits. As a consequence, instead of supplementing state unemployment benefits, severance plans have historically disqualified many employees from receiving state unemployment benefits. By contrast and as the name implies, SUB-pay plans are designed to supplement, integrate, or, as the Internal Revenue Service states, "link" with state unemployment benefits. The strength of those design features or links with state unemployment have vacillated over the years. Although SUB-pay plans were almost eliminated by the IRS in the early 1990s, traditional SUB-pay plans have a renewed platform as a result of the Supreme Court's decision in Quality Stores, 572 U.S. 141 (2014). Whether they will exist in five or 10 years will depend on further swings of the pendulum.

Financial Savings

The financial savings associated with a SUB-pay plan vary depending on the plan's structure, with one of the most significant variations focusing on whether the plan is an "offset benefit" or "full benefit" plan.

What is an offset plan? The first SUB-pay plans recognized by the IRS were almost all offset plans. In the decade prior to the Supreme Court's decision in Quality Stores, most new SUB-pay plans were full benefit plans. Post-Quality Stores, offset plans are resurging for legal, administrative, and financial reasons. Severance arrangements are typically structured as installment or lump sum payments computed as 100% of a laid-off worker's gross weekly, biweekly, or monthly gross payroll.

By contrast, an offset SUB-pay plan is designed and operated to pay a reduced percentage of gross pay. However, when added to the state unemployment benefits the terminated employee is eligible to now receive, those aggregate amounts will typically approximate 100% of gross wages. The intent is for the employee to receive a termination benefit of approximately 100% of gross payroll wages, but the employer's funding is reduced or offset by the state's payment of the unemployment benefits.

What are the potential financial savings associated with a properly structured offset SUB-Pay Plan? If properly structured, the employee can receive the same benefit payout as regular gross pay, but the state effectively picks up a significant portion of the employer's financial burden. The amount of the burden shifted to the unemployment system will vary but it can exceed 30% depending on variables such as the state, the employee's pay scale and the employee's employment service. With extended unemployment benefits in force, an offset plan can offer even greater financial savings to employers. How an employer utilizes those savings is within its total discretion—options include extending the payout period, providing reemployment incentive payments, or simply retaining the savings in the corporate treasury.

Tax Savings

A properly drafted SUB-pay plan offers tax savings regardless of whether it is an offset or a full-pay plan. Significantly, the tax savings exist at both the employer and the employee level. In particular, the tax savings come in the form of reduced employer and employee FICA taxes which in the aggregate are typically 15.3% of the amount paid. These savings can be retained at the employer or employee level or can even be used to extend the payout period for SUB-pay.

Origins

In the 1950s, many state unemployment statutes precluded an individual from receiving unemployment benefits for any period in which an employee received any type of wage payment from an employer. The steel and automotive industries and their associated labor unions searched for a solution that would allow employers to provide income supplements when employees were either temporarily or permanently downsized as a result of plant shutdowns, manufacturing retooling, or other similar unemployment periods. Unfortunately, the employer payments were treated as wages with the result that in many states the payments disqualified employees from receiving the very state benefits that the payments were intended to supplement. SUB-pay plans and benefits were structured in coordination with the states, the DOL, and the IRS as a method to bypass these historic disqualification rules by creating benefit plan payments that do not constitute "wages."

'Wages' for FUTA and FICA Purposes

The term "wages" for FUTA and FICA tax purposes means "all remuneration from employment" subject to certain statutory and, to a far lesser extent, administrative exclusions. Although more than 20 statutory wage exclusions exist for these Subtitle C provisions, none of the statutory exclusions references or has ever referenced SUB-pay. Since a statutory exclusion did not exist, the collective negotiations resulted in the IRS adopted new administrative positions and interpretations. Initially released as revenue rulings, the new form of benefit structure known as supplemental unemployment benefits paid benefits that were exempt from the definition of taxable "wages" which all of the negotiating parties agreed accomplished the state law objectives to not disqualify the recipients from receiving state unemployment benefits.

Tax Savings as Primary or Secondary Focus

Although almost all tax advisers and SUB-pay administrators focus on the significant FICA tax savings that SUB-pay plans offer, it is critical to note that the FICA tax savings were not the focus of the IRS's early revenue rulings. As the historic origins demonstrate, the true importance of the early IRS SUB-pay rulings was that the characterization of the payments as something other than taxable "wages" necessarily meant that the benefits did not disqualify the employees from receiving state unemployment benefits.

Rulings Implications

Early Rulings

While the original IRS revenue rulings had little to do with FICA tax savings, the secondary and corollary effect of the rulings was to necessarily exempt the payments from wages for FICA, FUTA, and FITW purposes. The rulings resulted in de minimis FICA tax savings to both employers and employees. In fact, the maximum employer FICA tax savings when the first revenue rulings were issued would not exceed $84 per employee since FICA taxes were subject to much lower tax rates and taxable wage bases.

To see the full article click here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.