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Considerations in Designing Severance Plans and Arrangements for Tax-Exempt Organizations

There are numerous reasons why organizations exempt from taxation under Internal Revenue Code Section 501(c) (3), as amended (the “Code” and, such organizations, “Tax-Exempt Entities”) may offer severance payments to employees who incur involuntary terminations of employment. For example, severance that is conditioned on the departing employee’s execution of a release of claims in favor of the Tax-Exempt Entity can reduce the likelihood of costly and burdensome litigation. Similarly, payment of severance may reduce the risk of negative publicity for the Tax-Exempt Entity by diminishing resentment felt by departing employees. Severance may also help retain existing employees by providing them with a measure of economic security that can dissuade them from seeking alternative employment, particularly if they suspect that the Tax-Exempt Entity has encountered budgetary shortfalls and may be implementing near-term workforce reductions. For these and other reasons, many Tax-Exempt Entities have either implemented or are considering implementing severance programs. Tax-Exempt Entities should be aware of unique opportunities and recent IRS regulations that impact the design of severance programs. This article discusses key decisions and planning opportunities for Tax-Exempt Entities to consider when designing and implementing severance plans and individual severance arrangements. Tax-Exempt Entities face a number of legal and regulatory challenges in establishing severance arrangements, particularly with respect to executive-level severance, as discussed in more detail in Part I. Part II discusses the legal parameters around using Code Section 403(b) retirement savings plans to offer severance to employees with lower levels of compensation.

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Proposed Changes to 409A Regulations Provide Greater Clarity and Planning Alternatives

On June 22, 2016, the Internal Revenue Service (IRS) issued proposed regulations to modify and clarify existing regulations under Section 409A of the Internal Revenue Code. The proposed changes were in response to practitioner comments and the IRS’s experience with Section 409A after the issuance of the final regulations in 2007. Overall, the proposed modifications are favorable to taxpayers and provide some planning opportunities. Plan sponsors have more flexibility to exempt arrangements from Section 409A and vary payment schedules under special circumstances. The IRS also made certain technical corrections to the existing regulations and warned taxpayers about certain practices that it considers to currently violate Section 409A. This article reviews the proposed changes, discusses available planning opportunities offered to employers, and addresses issues raised by the proposed regulations.

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