Income Tax Concerns In Connection With Severance-Related Release Agreements


It is a common practice for the payment of a severance benefit to be conditioned upon the severed individual’s execution of an agreement containing a release of claims against the ex-employer. Where such arrangement does not contain a compliant payment date or period (as described below), the ex-employee may be able to control the timing of the severance payment – and, in particular, the tax year in which the payment is made – based upon when he or she returns the executed release agreement, thereby raising the tax concern.

As discussed in a number of prior Client Alerts, Internal Revenue Code Section 409A provides certain permissible triggers (i.e., separation from service, disability, death, at a specified time or per a fixed payment schedule, certain changes of corporate ownership, certain unforeseeable emergencies) for the payment of “deferred compensation” subject to Section 409A, which may include severance payments. Section 409A generally permits the scheduling of such payments on the trigger date or within a period of not more than 90 days following its occurrence, provided that, if the post-trigger period spans two different tax years of the individual (e.g., separation from service occurs on November 15 and the agreement calls for the payment being made within 90 days thereof), solely the ex-employer (not the ex-employee) may determine whether to make the payment in the earlier or later tax year.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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