Severance Pay in the United States

Introduction: The Bifurcated Nature of US Severance Regulation

The regulation of severance pay in the United States operates within a complex, bifurcated legal framework that stands in stark contrast to the statutory dismissal indemnities common in European and Latin American jurisdictions. At the federal level, the United States maintains a posture of voluntarism rooted in the Fair Labor Standards Act (FLSA), which explicitly declines to mandate severance pay for terminated employees. Historically, this has relegated severance to the domain of private contract law, collective bargaining agreements, or employer benevolence designed to mitigate litigation risk.

However, this "at-will" baseline is increasingly illusory. A dense overlay of federal procedural statutes—governing notification, taxation, discrimination waivers, and benefit administration—combined with an aggressive expansion of state-level mandates has fundamentally altered the compliance landscape. As of 2025, the concept of "voluntary" severance is being eroded by "mini-WARN" acts in states like New Jersey and New York, statutory formulas in Maine and Puerto Rico, and the rigid interpretative doctrines of implied contract law.

This report provides an exhaustive analysis of this regulatory environment. It examines the intersection of the Worker Adjustment and Retraining Notification (WARN) Act, the Older Workers Benefit Protection Act (OWBPA), and the Employee Retirement Income Security Act (ERISA), while simultaneously dissecting the granular state statutes that determine the financial viability of workforce restructuring. Furthermore, it analyzes the critical 2025 adjustments to bankruptcy priority caps and IRS compensation limits that define the fiscal parameters of separation agreements.

The Federal Statutory Framework: Process Over Mandate

While the FLSA remains silent on the obligation to pay severance, federal law exerts profound control over the mechanics of severance through a triad of regulatory regimes: the WARN Act (notification), ERISA (administration), and the Internal Revenue Code (taxation).

The Worker Adjustment and Retraining Notification (WARN) Act

The WARN Act serves as the primary federal check on sudden workforce reductions. While technically a notice statute, its penalty structure—requiring back pay and benefits for the period of violation—effectively functions as a mandatory severance provision for non-compliant employers.

The Act creates a compliance obligation for employers with 100 or more full-time employees. The statute mandates a 60-day advance written notice to affected workers, the state dislocated worker unit, and local government officials prior to a "plant closing" or "mass layoff."

Severance as a Penalty vs. Offset: The critical intersection between WARN and severance pay lies in the penalty mechanism. An employer who orders a plant closing or mass layoff without the required notice is liable to each aggrieved employee for back pay and benefits for the period of the violation, up to 60 days. Federal courts have clarified that voluntary severance payments generally do not offset WARN liability unless the severance agreement specifically and unconditionally states that the payments are intended to satisfy the statutory WARN obligation.

The Older Workers Benefit Protection Act (OWBPA)

When severance is offered in exchange for a waiver of legal claims—a standard practice to mitigate litigation risk—the validity of that waiver is strictly governed by the OWBPA, specifically regarding claims under the Age Discrimination in Employment Act (ADEA).

For a release of ADEA claims to be enforceable against an employee aged 40 or older, the waiver must be "knowing and voluntary." This includes specific requirements such as plain language drafting, specific reference to the ADEA, and advising the employee to consult counsel. Furthermore, strict consideration periods apply:

Employee Retirement Income Security Act (ERISA) Implications

Severance pay arrangements often sit on the fault line of ERISA regulation. Under the Fort Halifax doctrine, a one-time, lump-sum payment triggered by a specific event (like a plant closing) typically avoids ERISA classification. However, if a severance policy requires an "ongoing administrative scheme"—such as managerial discretion to determine "cause" or "good reason" for resignation—it may be deemed an ERISA plan.

Tax Treatment: Withholding and Deferred Compensation

For federal income tax purposes, severance is treated as supplemental wages. As of 2025, employers must withhold at a flat rate of 22% for supplemental wages up to $1 million. If supplemental wages exceed $1 million, the mandatory withholding rate jumps to 37%.

Section 409A Compliance: To avoid the heavy penalties of Section 409A on deferred compensation, employers often utilize the "Involuntary Separation Pay" exception. For 2025, the Section 401(a)(17) compensation limit is $350,000. Therefore, the maximum amount that can be exempted under the "two times" rule for involuntary separation pay in 2025 is $700,000.

State-Specific Mandatory Severance: The "Mini-WARN" Revolution

While federal law focuses on process, a growing number of states have enacted substantive statutes mandating severance pay. These laws, often embedded within state-level WARN acts, represent a significant financial liability for employers operating in the Northeast and Caribbean territories.

New Jersey: The Millville Dallas Airmotive Plant Job Loss Notification Act

New Jersey effectively dismantled the voluntary nature of severance with its recent amendments. It is currently the most rigorous severance mandate in the continental United States. Unlike the federal WARN Act, New Jersey mandates that employers with 100 or more employees provide one week of severance pay for every full year of service to each employee affected by a mass layoff, transfer, or plant closing.

Maine: The Severance Pay Act

Maine strictly regulates facility closures and relocations. The statute applies to "covered establishments" employing 100 or more persons. Liability is triggered by a closing, relocation more than 100 miles away, or a mass layoff. In such events, the employer is liable to eligible employees for severance pay at the rate of one week's pay for each year of employment at that establishment.

Puerto Rico: Act 80 and the 2025 Statutory Formula

Following the nullification of Act 41, Puerto Rico's severance formulas reverted to the standards established by the 2017 Labor Transformation and Flexibility Act. For employees hired after January 26, 2017, the mandatory severance for unjustified dismissal is 3 months of salary plus 2 weeks of salary for every year of service, subject to a statutory cap of nine months of salary.

"Tin Parachute" Laws: Protecting Labor in Corporate Takeovers

A specialized subset of state statutes, colloquially known as "Tin Parachute" laws, mandates severance specifically when terminations occur following a transfer of corporate control. These laws are designed to discourage hostile takeovers financed by slashing the target company's workforce.

• Massachusetts: Employees terminated within 12 months of a transfer of control are entitled to two weeks of pay for each completed year of service.
• Rhode Island: Mandates severance for employees terminated within 24 months after a transfer of control, calculated at two weeks' pay for each year of service.
• Pennsylvania: Employees terminated within 90 days before or 24 months after a control-share approval are eligible for severance based on weekly compensation and years of service (up to 26 weeks).

The Interplay of Severance and Unemployment Insurance (UI)

The interaction between severance pay and state unemployment benefits is a patchwork of conflicting state policies. For multi-state employers, a uniform severance plan can yield vastly different net outcomes for employees depending on how the local workforce agency categorizes the payment.

Common Law Liability: The Implied Contract Doctrine

Beyond statutory mandates, employers face significant liability through the common law doctrine of implied contract. This is particularly prevalent in states that have eroded the presumption of at-will employment through judicial interpretation of employee handbooks.

Under the Woolley Doctrine (New Jersey), an employee handbook can create a binding contract if it contains provisions that a reasonable employee would interpret as a promise. If a handbook outlines a severance formula, a court may enforce this as a contract even if the employer intended it to be discretionary.

Similarly, regarding the limits of disclaimers, the Minnesota Supreme Court ruled in Hall v. City of Plainview that a general disclaimer in a handbook did not necessarily override specific, detailed promises found elsewhere in the text. To mitigate risks, employers should use discretionary language ("may receive") rather than mandatory language ("shall") in severance policies.

Bankruptcy and Insolvency: The Priority of Severance Claims

When an employer files for bankruptcy, the status of unpaid severance becomes a matter of federal bankruptcy priority. Under Section 507(a)(4), severance pay earned by an individual within 180 days prior to the bankruptcy filing is granted "priority" status.

2025 Cap Adjustment

The Bankruptcy Code mandates that the monetary cap for these priority claims be adjusted every three years. Effective April 1, 2025, the priority cap for employee wage/severance claims increases from $15,150 to $17,150 per employee. This means the first $17,150 owed is treated as a priority claim, paid after secured creditors but before general unsecured creditors.

Final Paycheck Logistics and "Waiting Time" Penalties

While distinct from severance per se, final paycheck laws dictate the timing of severance payments if those payments are classified as "wages" under state law.

• California: Final wages for a discharged employee must be paid immediately. Failure to pay severance immediately (if unconditionally owed) triggers "waiting time penalties"—a continuation of the employee's daily wage for up to 30 days.
• Massachusetts: Requires that any employee discharged be paid in full on the day of discharge. Failure to comply can result in mandatory treble damages (triple the amount owed) under the Wage Act.

Conclusion: The Strategic Imperative of Localization

The landscape of severance pay in the United States has shifted from a unified federal policy of non-intervention to a fragmented ecosystem of state-level compulsion. While the FLSA remains unchanged, the practical reality for multi-state employers is that "voluntary" severance is largely a myth in major jurisdictions. For corporate counsel and HR leadership, the critical takeaway is the necessity of hyper-localization. A severance policy designed for Texas creates massive liability exposure if applied in New Jersey or Puerto Rico.

Summary of Key 2025 Compliance Limits