As an employer, one of the most difficult parts of the job can be letting an employee go or eliminating their position. When the departure is an amicable one, many employers choose to provide a severance package. In some cases, an employment contract or union agreement may require severance pay no matter how the relationship ends.

Severance pay is often considered a way to protect goodwill and provide some relief to an employee who may encounter financial hardship in their transitioning period. However, Kentucky employers should realize that acceptance of severance pay by an employee does not eliminate that employee’s right to collect unemployment insurance. Some states have passed legislation which mandates a reduction in unemployment benefits for weeks in which a severance payment is made, but Kentucky is not one of them. Even if an employment contract provides for a waiver of unemployment benefits in lieu of a severance package, such a waiver could be deemed unenforceable by a court.

For unemployment reporting purposes, employers must report any gross wages which includes salaries, commissions, and bonuses. According to the Kentucky Office of Employment and Training Employer Handbook, severance pay is not a “wage” if it is paid under a plan that applies to all workers or to all of a class of workers and is computed based upon length of service. Accordingly, the tax related consequence of any severance package is important to take into consideration.

Unemployment rates in the state are high and employers often struggle to meet their numerous financial obligations. Severance pay can be a good business policy, but a severance agreement should be well-drafted and part of the employment negotiation process.