Expert: Allen - 9/20/2006

Question
A while back my boss terminated an employee ('ee) (oct 2005).  Upon termination she was given a month's severance pay.  A few months ago when our employeer ('er) funded her 2005 SEP she also sent this terminated employee her final 2005 SEP 'er contribution, based upon the 'ees 2005 salery.  The employee is now wanting additional SEP funds for the severance pay.  What is your take on it?  What IRS code section should I be looking at?

Answer
Unfortunately, this has been a gray area and there may not be a definitive answer. The closest that I can come to helping with your question is to refer you to the discussion of compensation in the proposed regulations under Section 415 of the Internal Revenue Code - see 1.415(c)-(2). This discussion probably would apply to contributions to a SEP.

Under the proposed regulation, compensation generally will not include severance pay that is paid after employment is terminated except for amounts received within 2 1/2 months of termination which would have been paid had the employee remained an employee (for example, unused sick pay or vacation pay or earned bonus). I believe you are referring to an extra payment that was not of this type, so I don't believe contributions are due on that extra pay if it was received after employment was terminated.

One problem with using this definition is that it applies to amounts received after termination. It is not clear about severance pay which is included in the last pay check if that check was received prior to termination.

Cutting through all this, if the employer was my client and he asked my opinion, I would say that a contribution is due if the severance payment was for unused leave or a bonus that the employee had earned but that a contribution is not due if it was an extra payment. I would say this even if it was included in the last pay check.

Note that this is only my opinion and it should not be relied on. You may want to obtain a legal opinion from an attorney who deals with pensions.