The economic and financial consequences of the ongoing COVID-19 crisis have forced some employers to furlough and lay off workers, resulting in record numbers of individuals claiming state unemployment benefits across the country. As a result, an increasing number of employers are considering implementing supplemental unemployment benefits plans (SUB-Pay Plans) in order to provide additional benefits to discharged employees. Unlike severance plans, SUB-Pay Plans can be structured to maximize employer savings while providing greater benefit to the employees. This is not always a quick fix, however, as there are numerous legal and administrative issues to consider when implementing a SUB-Pay Plan.

SUB-Pay Plan Benefits

SUB-Pay Plans are designed to allow employers to assist employees following involuntary terminations of employment by supplementing employees’ receipt of state unemployment compensation. Participants in SUB-Pay Plans are required to apply for and be eligible to receive state unemployment benefits prior to being eligible to receive SUB-Pay. This means that a SUB-Pay Plan is subject to the laws of each state in which it operates. Some states require that the employer submit the SUB-Pay Plan for pre-approval prior to implementation. This can cause significant delay in implementing SUB-Pay in those states. In addition, many states have other specific requirements, including requirements relating to eligibility and frequency of payments under a SUB-Pay Plan.

Once the SUB-Pay Plan is established, there are a number of unique benefits for both employers and employees, including the following:

• Unlike severance, SUB-Pay is classified as a benefit (as opposed to wages) and therefore is Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) exempt for both the employer and the employee.
• In most states, the payment of severance may reduce or eliminate the amount of unemployment benefits a former employee may receive from the state. This is not the case with SUB-Pay. Instead, in most states, SUB-Pay amounts will not impact eligibility for or the amount of state unemployment benefits.
• SUB-Pay may not be paid in a lump sum. Given the current economic landscape, employers may view this requirement as an advantage, as they may prefer to make payments in installments on a weekly or biweekly basis.
• Both severance and SUB-Pay can be provided in exchange for a release of claims against the company.
• A former employee who becomes reemployed or is no longer eligible to receive state unemployment benefits will also no longer be eligible to receive SUB-Pay, resulting in additional cost savings for the employer, as compared to a situation where the employer paid an upfront lump-sum severance payment, then rehired the employee a short time later.

SUB-Pay and the CARES Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides financial assistance to individuals and businesses with the goal of offsetting the economic damage from COVID-19. Although the CARES Act expands benefits available to unemployed individuals, it is silent on the question of the interplay between those enhanced unemployment compensation amounts and any SUB-Pay offered by employers, particularly in the following circumstances:

• Prior to the CARES Act, most states permitted unemployed individuals to receive state unemployment benefits for 26 weeks. The Pandemic Emergency Unemployment Compensation provision of the CARES Act provides unemployed individuals with an additional 13 weeks of unemployment benefits. It appears that employers could design their SUB-Pay Plans to provide an additional 13 weeks of SUB-Pay as well.
• The CARES Act incentivizes states to waive the waiting period, if any, before an unemployed individual can collect state unemployment benefits. States that waive the waiting period will have the first week of unemployment benefits 100 percent funded by the federal government. While not entirely clear, it appears that this would mean that any state that waives the waiting period with respect to state unemployment benefits would also waive the waiting period with respect to SUB-Pay. Employers that pay SUB-Pay may want to consider whether those benefits will begin immediately upon unemployment for states that have waived the waiting period.
• The CARES Act provides for special Federal Pandemic Unemployment Compensation of $600 per week in addition to regular state unemployment benefits. However, when calculating the amount of SUB-Pay to provide to discharged employees, it’s not clear whether employers must include the $600 additional payment in determining the value of state unemployment benefits. While there is no clear answer or guidance on this issue, arguably the $600 additional payment is a separate and distinct payment from state unemployment benefits. On the other hand, if the intent of the SUB-Pay Plan is to provide wage replacement of up to 100 percent, but not over, for the employee, then the employer may want to consider taking the $600 into account when calculating SUB-Pay, lest employees receive a windfall.
• The Pandemic Unemployment Assistance provision of the CARES Act provides unemployment benefits to individuals who are not traditionally eligible to receive state unemployment benefits. This includes individuals who have a limited work history. Prior to the CARES Act, those individuals would not be eligible for SUB-Pay if they were ineligible for state unemployment assistance. After the CARES Act, the SUB-Pay Plan may provide SUB-Pay to these newly eligible individuals as well.

Employers that had SUB-Pay plans in place prior to the CARES Act expansion of unemployment compensation may want to carefully consider how the provisions noted above may impact the calculation of SUB-Pay and/or implicate a need to amend plans to avoid unintended consequences. While there is no clear guidance on the interplay between SUB-Pay and the CARES Act, employers may want to consider these provisions of the CARES Act in the design and implementation of their SUB-Pay Plans.

Tax Implications

In Internal Revenue Service (IRS) revenue rulings and private letter rulings dating back to the 1950s, the IRS has taken the administrative position that SUB-Pay paid under a properly designed and administered plan is not subject to FICA or FUTA taxes. The IRS originally required employers to pay SUB-Pay from a trust that had been preapproved by the IRS.

Today, unless prohibited by state law, SUB-Pay may be paid from an employer’s general assets. Employers still have the option of creating and making payments from a tax-exempt trust, including an Internal Revenue Code Section 501(c)(17) trust or an Internal Revenue Code Section 501(c)(9) Voluntary Employees’ Beneficiary Association (VEBA) trust. While providing SUB-Pay through a tax-exempt trust fund is advantageous from a tax perspective, if an employer chooses to implement a trust, the employer must ensure that the trust meets applicable IRS qualification requirements. In addition, the employer is required to submit the trust to the IRS for preapproval. This may result in a delay in implementing the SUB-Pay Plan. Regardless of whether an employer chooses to pay SUB-Pay from a trust or from its general assets, the SUB-Pay will be exempt from FICA and FUTA taxes.

Looking Ahead

SUB-Pay Plans offer unique benefits to both employers and employees, but can be administratively burdensome, due to individual state law requirements. Regardless, particularly during this time of economic turmoil, a SUB-Pay Plan is an effective mechanism for employers looking to maximize cost savings while providing greater financial assistance to their discharged employees.