Severance Pay in Texas: A Primer
In Texas, severance pay plays a critical role in many employment agreements. Used as an incentive for greater retention, severance pay is compensation paid by the employer to incentivize employees not to quit their jobs. This specific arrangement is known as a retention payment plan, which is often included in an employment agreement.
Severance pay is not required by law in Texas, and federal overtime laws do not cover it as well. Severance can be offered to ease the employment contract termination process and prevent legal action against the employer. This does not mean that all severance provisions will hold up in an action alleging retaliation or wrongful discharge by the employee. Courts may determine that the employer terminated employment to avoid fulfilling its contractual severance obligation. If so, the courts may rule that the employer must pay the severance to the employee.
Often, severance arrangements will provide a specified dollar amount for each year worked for the employer , essentially rewarding longevity. Other arrangements require a specific number of years served prior to termination to be eligible for the set amount of severance pay.
Severance clauses can also require a requirement of the employee’s non-disclosure of proprietary information to others. These clauses sometimes seek post-employment restrictions on the employee’s ability to work for a competitor or start his or her own business. Generally speaking, employees have no duty to protect their employers just because they have been terminated, but severance pay may be contingent on the employee’s nondisclosure and non-competition.
Severance pays some employees their full salaries for a specified period of time in exchange for a release that allows the employer to terminate the employees without notice. The employer expects some settlement from the employee on previous claims in exchange for the full salary for a month or two after termination.
Laws on Severance Pay in Texas
Texas law is clear that there is no requirement that an employer give an employee a severance package upon the termination of their employment in Texas. Nor are employees entitled to a severance package upon a layoff or a termination. Even when employers offer severance packages it is important for the employee to make sure that the amount of the compensation to be received is much more than the employee would receive and/or be owed in the absence of the severance package.
When employees are laid off or "involuntarily terminated" from their employment, they must be paid for all hours worked up until the employee’s last day, and if they have accrued vacation pay, this may also be paid to them in a lump sum. Unfortunately, a Texas employer usually only has to pay an employee for unpaid wages, not a severance package, unless an employer has promised to pay the employee severance.
There may be instances where severance pay is common, and also instances where paying severance pay may be required. For example, many companies offer severance to employees voluntarily departing from the company when it will benefit the company, to help that employee with their transition; other companies may offer severance to employees that joined the company when it was acquired, but not to those hired after the acquisition.
Employers may occasionally offer severance packages to all employees, even though they are not legally required to do so. Severance packages generally contain several benefits, including: When reviewing a severance package, the most important consideration an employee should take into account, is what they would be entitled to if there was no severance package at all.
Agreements to Offer Voluntary Severance
Voluntary severance agreements also called "separation agreements" or "releases" have become an increasingly basic part of the severance negotiations process. As opposed to involuntary or negotiated severance, voluntary severance may be a special payment given in consideration for a waiver of liability on the part of an employee. These types of agreements are generally negotiated using a standard contract and are rarely verbal.
The situations in which a voluntary severance agreement may be offered include: sales or acquisitions, plant closings, mergers or consolidations, early retirements, reductions in force or changes in ownership. Typically, these agreements are offered to both hourly and salaried employees.
Voluntary severance agreements generally include certain final payments to the employee, such as any remaining compensation due to him or a her. Other terms may include holding the employer harmless against any claims, a non-disclosure agreement, an agreement not to solicit employees, and an agreement not to do business with the employer’s customers.
The parameters of a voluntary severance agreement should ideally be negotiated between the two parties. Also, if the employment agreement has a confidentiality clause, the severance agreement should either be kept confidential or mutually agreed to be disclosed.
Voluntary severance will usually have little if any effect on the employer’s taxes. Under section 404 of the Internal Revenue Code, an employer may make a current deduction for any severance payment made to an employee for post-employment services if the payment can be characterized as compensation under Section 4972(e) (2) of the Internal Revenue Code.
For the American employee, a good time to negotiate the terms of a voluntary severance agreement is just before the termination of employment or when an employee is offered a separation package. The severance benefits that may be negotiated include continuing health care benefits, lump sum payments, extensions of leave time, retirement benefits and accrual of seniority despite termination of employment.
Negotiations should involve consideration of economic security, whether the employment relationship has been a short term or long term position, the extent of the connection to the area or community, and the age and health of the employee.
Federal case law has upheld several forms of voluntary severance agreements and releases.
In the Fifth Circuit case of Dunn v. Calhoun County Commission, 203 F. Supp.2d 1335, the court found that the voluntary severance and release agreement between the former employee and employer was enforceable even though the agreement was not supported by separate consideration. In the American case of Balek v. Chemetron Corp., 2001 WL 1310525, the court found the same thing, upholding a voluntary severance and release agreement. However, in the case of Hughes v. Ogden, 2003 WL 22982704, a Federal District Court held that the voluntary severance and release agreement was not enforceable.
When negotiating a voluntary severance agreement an employee should keep records of the entire transaction of employment with a particular firm.
Calculating a Severance Package
Calculating Severance Pay Laws in Texas
Severance packages are not a transactional element of employment, meaning that as an employee you are not entitled to severance because of your employment and are not entitled to it even if it considered "standard" amongst other employees. So, the calculation of a severance package does not have a statutory formula from which it must be calculated. While, Texas law does not require severance packages, if it is offered, it is completely negotiable.
Oftentimes, though not always, employers will offer an employee a severance package to encourage the employee to leave and/or discourage the employee to sue for employment claims. The amount of severance has a large variability, and depends on a number of factors including your workplace history, the company’s workplace policies, company policies, and other circumstances.
When severance is offered, it will often correlate to how long an employee was employed (tenure/day’s worked) and your last annual salary. For example: an employer may offer you one month’s severance for every year that you worked at the company; or two weeks’ severance for every year’s worth of work. But not all severance will tie a financial aspect to your tenure, it could instead tie the severance to some other aspect of your work/life, such as the importance of your position within the company.
So, while there is no statutory requirement for severance pay, most companies develop a formula for severance that provides at least something to an employee who leaves the company. In Texas, it is often calculated as follows:
1) Determine the number of weeks of pay the company is offering you (if they are offering it):
2) Multiply that number by the amount you make per week:
($ Per Hour x 40) + ($Per 2nd Week = 2 x 40) + ($ Per 3rd week = 3 x 40)
3) Add that amount below to the amount of pay you will receive for the current week.
4) Add the specific dollar amount the employer suggested or you negotiated.
As with most rules, there are exceptions. The amount of severance may include bonuses and other "I owe you this" after a termination payments.
Smaller companies or local companies may not maintain as detailed of records of their employees and treat employees differently (based on an "informal" policy). If you are terminated, your severance may be calculated differently than your colleague who was also terminated.
While there is no law for companies to pay severance, it is also likely that they will continue to provide severance for employees, even if they do so on a case-by-case basis. It is up to you to determine what type of severance you feel you need and what type is appropriate based on your individual circumstances.
Legal Duties and Employee Rights
In addition to state and federal wage laws that require employers to adhere to the contracted terms of a severance agreement, Texas law also provides certain protections to employees. Perhaps most helpfully, the Texas Legislature recently added Chapter 51 to the Labor Code, titled "Voluntary Employment," which declares that severance agreements cannot constitute contracts of employment unless accompanied by a written document that expressly references the severance agreement and states it is a contract of employment . However, this new law will only apply prospectively to severance agreements entered into on or after September 1, 2013. Additionally, as noted above, the at-will employment presumption can be rebutted, which provides employees another potential cause of action if an employer attempts to deny or modify certain aspects of a duly executed severance agreement.
Taxes on Severance
Settlements and very large severance packages are taxed as ordinary income at the end of the year they are received. Severance pay is taxed in the same manner as your regular salary or wages.
From a tax perspective, your salary and severance are both ordinary income, so the treatment for each is the same. However, the information reported on your W-2 is different. In 2017, the IRS introduced a new form for reporting severance pay called the IRS Form W-2c. In short, it’s a correction to a previous IRS Form W-2. You will receive a revised W-2c or other IRS replacement form with the appropriate information. Report the income shown on your W-2c or other IRS replacement form on your individual tax return. Again, treat it as your salary or wages.
Severance pay may also be considered supplemental wages. Supplemental wages include two categories: non-discretionary payments and discretionary payments. Before you go down this rabbit hole, realize that non-discretionary and discretionary payments are often referred to as supplemental wages.
Non-discretionary payments, which are considered as income, include bonuses, commissions, and severance pay. On the other hand, discretionary payments, which are considered as non-income, include gifts, payments in recognition of life events or illness, and payments after termination of employment. Bonuses, commissions, and severance pay are all non-discretionary supplemental wage payments which are subject to withholding.
If your employer withheld federal income tax from the severance, it likely did so at a flat rate of 25 percent for 2022. I have represented many people who have received non-discretionary supplemental wage payments with the 25 percent federal withholding rate applied to the payment. Despite this, when you file your return, the tax system has no knowledge of the payment and its withholding. The tax system treats non-discretionary additional payments similar to your regular paycheck during that tax year.
When you file your return, two things happen: Under the second bullet, it is important to also understand how the rest of your income from your job or other sources such as interest or dividends are treated in your tax return because it could raise your overall tax rate.
Note: If you have received non-discretionary supplemental wage payments in one or more previous years, your average income tax rate may be higher because of the increase in income. It’s possible you received a tax refund when you filed your return due to over withholding of federal income tax. This is an exception. Your tax rate is determined on your tax return, but it’s not lowered because the IRS withheld more taxes than actually owed.
The takeaway: If a lump-sum severance payment is made and it results in a 25 percent withholding and your effective tax rate is 20 percent for that tax year, you should receive a tax refund when you file your tax return. Also, if you have recurring payments in the current year with 25 percent withholding, you need to consider that you may owe a balance if it changes your effective tax rate.
Severance Pay with Layoffs or Terminations
Severance pay can serve as a form of compensation to help a terminated employee find their feet following a termination or layoff. It is not generally required under Texas law, but can be an important part of negotiating a favorable exit for some employees.
Severance pay offered during a layoff or termination often relates to the employee’s length of service with the company. The size of a severance payment, in these cases, typically increases in lockstep with seniority. An employee with less than a year of service may receive a one week’s pay as severance, while a worker with 30 years of service might be offered two years’ pay. Severance pay can also be covered by an insurance policy, or based on the value of stock held in a pension plan. Whatever the basis for the severance payment, it is typically offered only when an employee is involuntarily terminated. It is usually designed to help that individual transition into a new job. So, while you will not likely receive severance pay if you quit your current position, you will almost certainly receive it if you are laid off or terminated, and can use that money to pursue employment elsewhere. In the event an employee is not offered severance at time of termination, they can seek either legally mandated or common law damages. Under some state and federal employment laws, severance is considered part of the minimum compensation that an employer may be required to provide upon termination. In this case, severance represents a type of compensation, and can be classified as wages. There are situations, however, in which severance is offered without any expectation of its eventual repayment. If this is the case, an employee may be asked to sign a general release waiving their right to file a lawsuit against the company for wrongful termination. In some cases, an employer will agree to waive the requirement that a terminated employee sign a general release in exchange for the employee agreeing not to file a wrongful termination lawsuit.
Conclusion & Advice
As you can see, severance pay in Texas is a nuanced subject that can result in many pitfalls for the unwary. We hope this article has given you a clearer understanding of what to look for in your severance agreement and the issues that can arise. Because severance pay can have significant impacts on a number of different benefits , it is useful to consult with someone experienced in severance agreements to ensure you understand your rights and obligations under both the agreement itself as well as the federal and state laws that may apply to you. This also includes reviewing your employment contract with your employer (if any), any collective bargaining agreement covering you, as well as any.
If your severance agreement requires you to sign a release of claims, your waiver of legal rights is almost certain to be enforceable unless you contact an experienced disability or employment law attorney to review it for you.
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