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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On June 22, 2016, the Internal Revenue Service (IRS) issued proposed regulations under Section 457(f) of the Internal Revenue Code of 1986, as amended (Code). These long-awaited regulations were first previewed in IRS Notice 2007-62. In that Notice, the IRS announced its intention to issue proposed regulations that would harmonize the rules for deferred compensation plans of tax-exempt organizations (and state and local governments) under Section 457(f) with the then-new special rules for all deferred compensation arrangements under Section 409A. After nine years, the proposed regulations now issued address three principal issues, although with some unexpected changes and opportunities.

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