May 26, 2020

Severance and Deferred Compensation Consideration for Tax-Exempt Colleges and Universities

In-house counsel and human resources professionals at tax-exempt colleges and universities often face a variety of challenges when structuring, and determining obligations due under, severance arrangements. There are some key considerations to bear in mind, which are outlined in this article.


Considerations When Structuring Severance Arrangements

Negotiating When Severance Is Due: Severance arrangements often provide payment only on an employee termination by the employer without “Cause” (e.g., employee’s failure to follow directions from superiors, commission of a crime involving dishonesty or fraud,) or by the employee for “Good Reason” (e.g., material salary reductions, relocation requirements). These terms are often among the most heavily negotiated in employment and severance agreements.

Deciding What Severance Benefits to Give: Severance generally includes cash payments based on a multiple of salary (e.g., 12 months’ base salary). But severance may also consist of other payments or perquisites, such as an employer subsidy for COBRA coverage premiums. Executive-level benefits can be quite varied, and may include post-termination limited employment, tuition benefits for the employee’s dependents, and continued use of an office, library, gymnasium or other facility. An institution might consider spreading severance pay over more than one calendar year to avoid reporting a large number in a particular year (see “Reporting” below).

Restrictive Covenants: Especially at senior levels, severance is often conditioned on signing a release of claims and compliance with post-termination obligations. These releases often include restrictive covenants, including obligations not to compete, not to solicit other employees, to maintain the confidentiality of non-public information and not to disparage the employer. Release agreements require the employee to surrender the right to bring certain employment related claims against the institution.

Excise Tax Considerations: The Tax Cuts and Jobs Act of 2017 implemented two excise taxes on private universities. The first imposes a 21% excise tax on covered institutions on amounts paid to “covered employees” in excess of $1 million in any calendar year. The second is a 21% excise tax on payments to covered individuals in excess of three times their average compensation over the five years preceding the year of termination which are “contingent” on their separation from service. Carefully structuring severance arrangements in advance can mitigate or eliminate these excise taxes.

Tenure: Because universities generally cannot terminate tenured faculty members except for adequate cause or under extraordinary circumstances because of financial exigencies, universities often offer voluntary retirement incentive programs. For example, the university might offer tenured faculty two years’ pay, retiree medical coverage, and continued use of an office and campus facilities on turning age 68 but have the offer expire or reduce at age 70. A voluntary early retirement program would generally be in lieu of, and not addition to, other severance payments, and program documents should reflect that.

Considerations When Severance Is Due

Determining Which Documents Provide for Severance: Determine which arrangements provide for payments upon termination of employment and how those arrangements fit together. Review any relevant documents (e.g., the employee’s individual offer letter, employment agreement and/or severance agreement, and any amendments). Next, locate and review any broad-based severance plans or policies. Finally, ensure that there are not any severance commitments being made to the terminated employee orally or by email. Employment termination is also a distribution event under tax-qualified retirement plans (and often non-qualified retirement plans), so those should be examined as well to determine whether benefits may be distributable.

Reporting: Private institutions generally must file an annual report on IRS Form 990, which requires institutions to report tax-year compensation for a number of individuals, including current officers, directors and trustees. States often have similar reporting requirements. Severance pay is included in the compensation disclosed, and, in order to avoid negative press, institutions often try to avoid reporting a large severance figure in a single year.

While this article provides an overview of severance and deferred compensation considerations for tax-exempt colleges and universities, we highly recommend consulting with legal and tax professionals before implementing severance arrangements, and again when severance and/or deferred compensation obligations are due.

© 2020 McDermott Will & Emery


About this Author

Joseph K. Urwitz, Employee Benefits Lawyer, McDermott Will Emery Law Firm

Joseph K. Urwitz is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Boston office.  He focuses his practice on employee benefits, executive compensation and ERISA matters.  Joe’s experience includes ERISA fiduciary issues, benefits issues faced by non-profit entities, executive compensation and deferred compensation arrangements, equity award plan design, employment and severance arrangements, qualified plan work and employee benefits matters arising in mergers and acquisitions.

Joe received his J.D. from the University of Chicago Law School...

Todd A. Solomon apension 401k attroney  McDermott Will & Emery LLP, Chcago

Todd A. Solomon is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.  Todd focuses his practice primarily on designing, amending, and administering pension plans, profit sharing plans, 401(k) plans, employee stock ownership plans, 403(b) plans, and nonqualified deferred compensation arrangements.  He also counsels privately and publicly held corporations and tax-exempt entities regarding fiduciary issues under ERISA, employee benefits issues involved in corporate transactions, executive compensation matters, and the implementation of benefit programs for domestic partners of employees. 

Todd has significant ERISA Title I experience and has counseled plan fiduciaries with respect to investment policies, private equity, hedge funds, and other alternative investments, prohibited transaction issues, investment management agreements and payment of expenses from plan assets.

He advises multinational clients on global employee benefits matters and compliance issues. Todd is a council member of the International Bar Association Global Employment Institute (GEI) and serves as editor of the GEI’s Annual Global Report on global legal issues impacting human resources.

Todd represents clients before the Internal Revenue Service on issues such as Employee Plans Compliance Resolution System (EPCRS) filings, Audit Closing Agreement Program (CAP) negotiations, benefit plan audits and applications for determination letters. He negotiates with the Department of Labor in connection with benefit plan audits and Voluntary Fiduciary Correction Program filings, and the Pension Benefit Guaranty Corporation in connection with 4062(e) events and plan terminations.

Todd chairs the Firm's Pro Bono and Community Service Committee. He received the 2008 McDermott Will & Emery award for Outstanding Achievement and Commitment to Pro Bono and Service to the Community. Additionally, he is a member of the McDermott's Diversity and Inclusion Committee and has been involved with evaluating the Firm's domestic partner benefits policies and working with businesses in Chicago in jointly advocating for lesbian, gay, bisexual and transgender (LGBT) rights in the workplace.