Supplemental unemployment benefit plans: A tool for employers responding to the COVID-19 crisis

A version of this article originally appeared in June 2020 edition of Employee Benefit Plan Review.

It goes without saying that no one can predict with certainty the full economic impact of the COVID-19 crisis. Employers are approaching the crisis in very different ways depending on how deeply, and for how long, they expect the crisis to adversely impact their business operations. In worst-case scenarios, employers are closing their doors permanently with no plans to reopen. In other cases, employers are trying to conserve resources in order to ride out the economic downturn caused by the crisis. Such conservative actions may include reduction in force (RIF) programs whereby some employees are involuntarily terminated, with only those employees considered essential to the survival of the business retained.

Delayed employment Taxes under CARES Act

The Coronavirus Aid, Relief and Economic Security (CARES) Act includes a number of measures that offer relief to employers struggling to survive during this difficult period. Among them is a provision permitting employers to delay the payment of the employer portion of Social Security taxes (FICA) that are due to be made during the period from March 27, 2020 through December 31, 2020. Payment of the first 50% of these employment taxes can be delayed until December 31, 2021. The remaining portion must be paid no later than December 31, 2022. Unlike other provisions of the CARES Act, there is no need-based eligibility requirement and the relief is not limited with respect to the type and amount of wages. Thus, all employers are eligible and payment of the employer portion of FICA taxes due on severance payments, reported as wages, can be delayed under this provision.

Employers that qualify for this relief must not have availed themselves of the debt relief offered under another CARES Act measure, the Paycheck Protection Program (PPP). Under the PPP, certain small businesses with fewer than 500 employees may apply for loans to maintain payroll and health plan coverage. As of this writing, the loans are available through June 30, 2020. The PPP offers forgiveness for the portion of the loan used for payroll, benefit and certain other costs during the eight-week period following the date of the loan origination.

Because the employment tax relief and the debt forgiveness under the PPP are mutually exclusive, employers must weigh the pros and cons of these relief measures as well as other COVID-19 programs offered by the federal government. In doing so, it is good to consider pre-CARES Act vehicles that allow employers to assist employees who have been involuntarily terminated while achieving employment tax savings.

Employment tax exemption for supplemental unemployment benefit plans

A supplemental unemployment benefit (“SUB”) plan is designed to provide additional protection to employees in the event of involuntary termination of employment. If certain requirements are satisfied, SUB plan benefits are subject to federal income tax, but exempt from FICA and FUTA taxes.

SUB plan benefits must be paid only to unemployed former employees who are involuntarily terminated due to a reduction-in-force, location closure or a similar condition. Generally, eligibility for SUB plan benefits must depend on continued eligibility for state unemployment compensation. However, if desired, a SUB plan may expand eligibility to a former employee who is no longer eligible to receive state unemployment compensation because the former employee has (i) insufficient wage credits for state unemployment compensation, (ii) exhausted the period for state unemployment compensation; or (iii) failed to satisfy a required waiting period for state unemployment compensation, provided that benefits will commence once the waiting period expires.

Unlike severance plans, SUB plan benefits may not be paid in a lump sum. Rather, the payment must be linked to the continued receipt of periodic state unemployment compensation. Even in the case of former employees who have exceeded state unemployment compensation limits or have insufficient wage credits, SUB plan benefits must be paid periodically as if the individual still qualified for state unemployment compensation.

Typically, the amount of weekly benefits payable is based upon state unemployment compensation and the amount of regular pay, i.e., the SUB plan benefits are designed to restore a former employee to all or a portion of his or her pay prior to termination of employment. However, SUB plan benefits must not be attributable to the performance of services after termination of employment.

A SUB plan can provide for different levels of benefits depending on job position or length of service. SUB plan benefits can be funded out of the employer’s general assets or a tax-exempt trust satisfying the requirements of Section 501(c)(17) of the Internal Revenue Code of 1986, as amended (Code).

Because a SUB plan provides benefits that will subject to federal income tax in a future tax year, the plan will be subject to the rules applicable to nonqualified deferred compensation under Code Section 409A unless an exemption applies. Many employers design a SUB plan to qualify as a “separation pay plan” that is exempt from Section 409A. Under the separation pay plan exemption, benefits:

• Must be paid only on involuntary termination of employment;
  
  
• Cannot exceed the lesser of (i) two times the employee’s annualized compensation for the prior calendar year, or (ii) two times the Code Section 401(a)(17) limitation on compensation (for 2020, $570,000 (2 x $285,000)); and
  
  
• Are received over a period not exceeding 2 years.

Under Section 409A, termination of employment must include termination with all members of the employer’s controlled group and otherwise qualify as a “separation from service,” as defined in Section 409A regulations.

Most SUB plans are also designed as welfare benefits plans for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Benefits must not be contingent, directly or indirectly upon the employee retiring and the plan must satisfy requirements similar to the Section 409A separation pay exemption, i.e., benefits do not exceed two times the employee’s annual compensation for the prior year and are paid not later than 24 months after termination of employment. While exempt from the ERISA coverage, vesting and nondiscrimination rules applicable to retirement plans, a SUB plan will be subject to the ERISA provisions applicable to welfare plans, including reporting and disclosure requirements and claims procedures.

Tax-exempt employers will also have to consider compliance with Code Section 457(f) in drafting SUB plans.

Because SUB plan benefits must be tied to state unemployment compensation programs, a SUB plan must include administrative provisions that are designed to ensure that benefits are in sync with the applicable state unemployment insurance program. For example, the plan might require the former employee to demonstrate that he or she has reported to, and registered with, the state unemployment office for state unemployment insurance benefits. In addition, the plan might set forth procedures whereby the former employee is required to demonstrate weekly continued eligibility for state unemployment compensation benefits, including, if required by the state, that such former employee is available for work and actively seeking work. Finally, the former employee might also be required to document whether he or she is ineligible for state unemployment compensation, e.g., due to insufficient wage credits or exhaustion of state unemployment compensation.

In drafting a SUB plan, an employer will want to give particular focus to defining the eligible group of employees. For example, an employer may want to specifically exclude employees who are terminated for cause or employees who are subject to individual severance agreements. The employer may also condition eligibility upon the employee’s execution of a release (without revocation). There may also be some job positions that the employer wants to exclude. The employer will also want to give careful consideration to the appropriate level and duration of SUB benefits.

Conclusion

Unlike the payroll tax delay provision under the CARES Act, a SUB plan provides a permanent exclusion from both the employer and employee portion of FICA taxes as well as FUTA taxes. Moreover, maintenance of a SUB plan will not prevent an employer from availing itself of PPP debt relief. If an employer has the resources to provide some assistance to involuntarily terminated employees and the ability to comply with the ongoing administration, a SUB plan may provide a viable option for dealing with the COVID-19 crisis in a way that benefits both the employer and former employees through severance benefits and employment tax savings.

Lori Jones is the chair of Thompson Coburn’s Employee Benefits practice.

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