Utilizing sub-pay plans as a tax planning stpategy.

• Author: Lihzis, Bryan

In the face of increasing national and international competition, Fortune 1000 companies are continually assessing their corporate tax strategies to find new ways to maximize cash flow and reduce their tax burden.

Corporate finance departments often focus on employee benefit plans to look for ways to improve efficiencies, control costs and increase tax savings. CFOs and tax specialists should also examine company severance plans to ensure these programs are designed and administered on a tax-advantaged basis. What many companies do not realize is that there is an IRS-compliant severance strategy that offers significant tax savings.

Cut Costs and Increase Cash Flow

U.S. companies that routinely pay severance benefits, or expect to pay such benefits as a result of a merger, acquisition, business realignment or seasonal employment, may be able to realize substantial Social Security and Medicare tax (FICA) savings for them and their employees by structuring these payments under a Supplemental Unemployment Benefit Payment ("SUB-Pay") Plan.

Traditional severance plans do not provide adequate tax advantages. In addition, lump-sum severance payments hit a company's balance sheet and cash reserves immediately and impose a significant administrative burden. Conversely, a SUB-Pay Plan is a better overall tax strategy that lowers severance costs, reduces a company's administrative workload, and provides more benefits to laid-off workers due to the FICA tax exemption.

What Is a SUB-Pay Plan?

Introduced by the IRS in 1956, SUB-Pay Plans save payroll tax dollars and enable the company to use their paid-in asset of state state unemployment insurance (UI) taxes to supplement state UI benefits with separation pay. When combined, these benefits provide the laid-off worker with up to 100 percent of their pre-layoff wage.

SUB-Pay Plans can save companies 7.65 percent-45 percent or more in severance costs from payroll tax savings and the coordination of UI benefits. Furthermore, SUB-Pay benefits are paid on a periodic basis, reducing the cash flow impact to the company.

U.S. Supreme Court's Recent Landmark Tax Ruling

In what many consider to be the most significant payroll tax opinion issued in the last 30 years, on March 25, 2014, the U.S. Supreme Court ruled in favor of the IRS in United States v. Quality Stores, Inc., deciding that severance payments employers made to laid-off employees are "wages" and are taxable under FICA. The immediate fallout from this...