Supplemental Unemployment Benefits for Laid Off Employees

Like many small businesses, you may be forced to make some tough financial decisions because of the COVID-19 crisis. This might include reducing your workforce through temporary or permanent layoffs. But with COVID-19 having a severe economic impact on the United States economy, you may want to help your displaced workers in some way.

If you have enough resources, you can assist by offering a Supplemental Unemployment Benefit (SUB) Plan.

What is a Supplemental Unemployment Benefits (SUB) plan?

A SUB plan is a cost-cutting alternative to providing severance to employees who have been involuntarily terminated. SUB plans work by filling the gap between the discharged employee’s state unemployment compensation and their regular wages prior to the separation.

Unlike traditional severance, the money paid through the SUB plan is exempt from payroll taxes if certain conditions are met. For starters, the plan must link to the receipt of state unemployment benefits.

How are Supplemental Unemployment Benefits plans linked to state unemployment benefits?

Generally, the discharged employee must be unemployed and eligible for state unemployment benefits in order to receive payments through a SUB plan.

Employers often make SUB plan payments while the discharged employee is actually receiving state unemployment compensation. However, if the plan chooses, it can extend eligibility to a discharged employee who is no longer eligible for state unemployment benefits because they:

1. Do not have enough wage credits for state unemployment benefits
2. Have exhausted the length of their state unemployment benefits, or
3. Do not meet a required waiting period for state unemployment benefits

The discharged employee must be unemployed and eligible for state unemployment benefits in order to receive payments through a SUB plan.

Do Supplemental Unemployment Benefits plans have to be approved by the state?

In some states, employers cannot implement a SUB plan without pre-approval from the state unemployment compensation agency. The state may also have other requirements for SUB plans, such as regarding eligibility and payments.

If the state does not require pre-approval, it might encourage employers to submit their SUB plan for approval anyway, as lack of approval will cause the payments to be treated like traditional severance.

Traditional severance is taxable and the unemployment agency takes the amount into consideration when determining the discharged worker’s eligibility. For example, traditional severance can reduce unemployment benefits, or even render the discharged worker ineligible. Conversely, payments made through a state-approved SUB plan do not reduce state unemployment benefits or impact eligibility.

The SUB plan may need to obtain tax-exempt status from the IRS before it can be approved by the state.

What taxes are exempt under a Supplemental Unemployment Benefits plan?

Payments made through a SUB plan are excluded from Social Security and Medicare taxes, plus federal and state unemployment taxes if the legal requirements are satisfied.

The SUB plan payments “must be specifically designed to supplement state unemployment benefits.”

One requirement, according to IRS Revenue Ruling 90-72, is that the SUB plan payments “must be specifically designed to supplement state unemployment benefits.” Further, “Under the terms of the plan, the employee must be unemployed and must meet the requirements necessary to receive state unemployment compensation benefits.”

Additionally:

• The SUB plan payments must be made in installments, meaning over time. Payment cannot be a lump sum.
• The discharged worker must have been involuntarily terminated, such as through layoff, plant closing, or reduction in force.

SUB plan payments are not exempt from federal or state income tax withholding.

How are payments made?

Unless the state says otherwise, you can make SUB plan payments from your general assets. Alternatively, you can establish — and pay through — a tax-exempt trust that conforms to IRC Section 501(c)(17).

Also, the employer, the employee or both can fund SUB plans. In the private sector, the employers often fund them.

How much does the Supplemental Unemployment Benefits plan pay?

SUB plans pay the difference between the discharged employee’s state unemployment benefits and their regular wages before the layoff.

For example, the discharged employee receives $375 in state unemployment benefits and their weekly pay used to be $575. The SUB plan would pay the difference of $200 per week.

Summarizing Supplemental Unemployment Benefits plan benefits

Both the employer and the discharged employee save on payroll taxes — unlike traditional severance, which is taxable.

• Both the employer and the discharged employee save on payroll taxes — unlike traditional severance, which is taxable.
• You do not have to come up with a lump sum payment, unlike some traditional severance agreements. By making installment SUB plan payments, you can better manage your cash flow, which is especially critical during an economic downturn.
• SUB plans help cushion the blow of a layoff by offering much-needed financial support to displaced workers.
• SUB plans allow furloughed employees to maintain a steady income while waiting to be called back to work. This gives them peace of mind while enabling you to retain valuable workers.
• SUB plan payments do not affect the amount of state unemployment benefits received or eligibility, unlike traditional severance.
• Similar to traditional severance, employers may give SUB plan payments in exchange for the employee releasing claims against the company. However, this should be done strategically and legally.

SUB plan adoption challenges

• If the SUB plan must be submitted to the state or the IRS for pre-approval, this could considerably delay implementation.
• The SUB plan must be carefully designed to ensure the employer and the employee get the most out of the program. This step requires strong knowledge of how SUB plans work and the related laws and tax implications.
• SUB plans are typically more complicated to administer than traditional severance plans, mainly because of their association with state unemployment benefits.
• SUB plan payments are subject to federal income tax withholding and must therefore comply with IRS rules for nonqualified deferred compensation — unless an exception applies. To meet this exception, employers often design their SUB plan as a “separation pay plan.”
• SUB plans are usually considered welfare plans under the Employee Retirement Income Security Act of 1974. This means the plan must adhere to applicable ERISA laws, including developing a written plan document.

A growing trend that packs an administrative punch

The COVID-19 crisis has increased employers’ interest in SUB plans, and many employers are reportedly offering them as a result. These plans, which have been around for decades, are now being recognized as a viable alternative to traditional severance amidst the coronavirus economic fallout.

However, SUB plans can be cumbersome to administer. For this reason, it may be best to hand over the administrative reins to a third party that specializes in this type of workplace benefit.