Severance agreements are an essential part of employers’ termination process but require careful drafting to provide employers with optimal benefits. Generally, employers draft severance agreements containing provisions that release employers from past and prospective liability in exchange for severance pay or other benefits. By signing a severance agreement, a terminated employee waives claims that he or she may otherwise assert against the employer. There is no cookie-cutter example of a severance agreement, but attorneys commonly draft severance agreements that include covenants not to sue, confidentially clauses, and cooperation clauses. The purpose of this article is to help employers modify specific clauses in their existing severance forms to limit potential liability.
Exercise Caution when Drafting Severance Agreements with Covenants Not to Sue
While the Equal Employment Opportunity Commission (EEOC) permits employers to draft severance agreements that reduce employers’ potential exposure to liability, the EEOC initiates civil action against employers denying employees their “full exercise” of rights, including the right to sue. According to its Strategic Enforcement Plan for 2013-2016, the EEOC intends to “target policies and practices that discourage or prohibit individuals from exercising their rights under employment discrimination statutes . . . [including] settlement provisions that prohibit retaliatory actions.”
So what does this mean for Idaho? Get rid of covenants not to sue in future severance forms! Idaho employers with severance agreements prohibiting an employee from filing a charge are subject to civil action bought by the EEOC, unless altered immediately and strategically. It is important to modify future agreements by adding a provision clearly stating that the agreement will not interfere with the employee’s rights. An example of such a provision would read: “Nothing in this agreement shall interfere with employee’s rights under federal, state, or local civil rights or employment discrimination laws.” Idaho employers may still require employees to release all claims to monetary damages, but include covenants not to sue at your own risk.
Severance Payments are Subject to FICA Withholdings
In addition to enforceability issues, a recent United States Supreme Court decision may change how Idaho employers withhold Social Security taxes. In March 2014, in United States v. Quality Stores, the Supreme Court unanimously held that severance payments made to employees who are terminated against their will are subject to both federal income tax and FICA (Federal Insurance Contribution Act) tax. The FICA tax includes two separate taxes that are split between employers and employees: Medicaid and Social Security. Employers are subject to FICA withholdings, unless employers are exempt under the Supplemental Unemployment Benefit Plan (SUB Plan). Under the SUB Plan, employers can link severance payments to employees’ receipt of state unemployment benefits. However, due to the SUB Plan’s rarity, employers should assume that their severance payments are subject to FICA withholdings.
In Quality Stores, an agricultural retailer closed all 374 of its stores and filed for Chapter 11 bankruptcy. Under its severance agreements, salaried employees received 5.2 weeks of severance, and hourly employees received 3.1 weeks of severance. Initially, Quality Stores withheld both federal income tax and FICA tax based on its severance payments but subsequently filed an adversary action in bankruptcy court to recover its employees’ half of the FICA taxes. The Supreme Court denied the employer’s request, holding that severance payments are a form of remuneration for employment and should be taxed like regular wages.
To avoid any tax liability, Quality Stores demonstrates that Idaho employers must accomplish two tasks. First, employers must note severance payments as wages on W-2 forms. Second, employers must withhold federal income tax and FICA tax, unless they can prove that payments fall under the narrow SUB Plan exception.
INSIGHTS FOR EMPLOYERS
To minimize the possibility of litigation after employees sign severance agreements, it is important for Idaho employers to make a few adjustments to their current agreements:
Please contact a Gjording Fouser lawyer at 208.336.9777 if you would like any additional information about this topic or any other employment issues facing your company.