6.1 Severance-Related Payments
The most common type of payment to a terminated employee is severance pay, which is taxable compensation. (IRS Treasury Regulation 1.61-2(a)(1)). Severance pay is taxable even if, as part of their separation agreements, departing employees sign waivers releasing their former employers from potential future claims, including claims of unlawful discrimination. Executive employees may receive severance pay as consideration for the cancellation of an employment contract. The lump sum payment received by an employee as consideration for the cancellation of his employment contract constitutes gross income to the recipient in the taxable year of receipt. Thus if the payments are made by the university/agency to the employee upon his involuntary separation from the service and were in the nature of dismissal payments (relinquishment of interests the employee had in his employment contract), then the payments are not considered wages subject to FICA and federal withholding. However, these dismissal payments are subject to taxation as ordinary income to the employee reportable on a 1099. (IRS Revenue Ruling 58-301). If the payments are made pursuant to the provisions of the contract rather than as consideration for the relinquishment of interests the employee had in his employment contract, then the payments are considered wages subject to FICA and federal withholding. (IRS Revenue Ruling 74-252).
An employee who contracts in advance for their wages to be delivered to the university/agency rather than being paid directly to himself/herself does not avoid imposition of income tax. The payments are taxable to the employee regardless of to whom they are paid and are considered anticipatory assignment of income. An employee who enters into such an agreement, or receives the payment and then donates it to the university/agency may be entitled to a charitable deduction on their personal tax return to offset the income. (IRS Revenue Ruling 74-32, 1974-1 CB 22; Loeffler vs. Commissioner; and Tax Court Memo 1983-503). A situation that might involve anticipatory assignment of income would be when a faculty member who gave continuing education presentations for a flat fee contracted in advance for the payment to be delivered to their department at the University, thereby trying to avoid imposition of income tax on the payment. The faculty member may indeed give it to the department; but, the income will be considered taxable wages to the faculty member.
An honorarium generally involves a payment that is made to a person in exchange for services for which no specific fees were required or requested. Honorariums are considered taxable compensation if the honorarium would not have been paid “but for” the services rendered, i.e. a speech, lecture. If, however, the honorarium is paid directly to the individual’s employer and never offered (see section 6.2 “Assignment of Income” above) to the individual, the individual would not be required to include the honorarium in gross income because the payment did not personally benefit the individual. For example, a horticulture professor delivers a speech on a topic pertaining to his expertise at a local convention without charge. In appreciation of the professor’s speech, the sponsoring organization gives the professor a cash honorarium. The IRS would most likely consider the honorarium to be taxable compensation on the grounds that the honorarium would not have been paid “but for” the services rendered. If, however, the honorarium was paid directly to the Horticulture Department and never offered to the professor, the honorarium would not be included in taxable compensation.