Subject: Deduction for Severance Wages
Tax: Individual Income Tax
Statute: G.S. 105-134.6(b)(11)
Issued By: Personal Taxes Division
Date: April 1, 1998
Date Modified: May 24, 2017
(This Directive was revised on May 24, 2017 to reflect the repeal of G.S. 105-134.6(b)(11) which was effective for taxable years beginning on or after January 1, 2014.)
This directive addresses the individual income tax deduction for severance wages allowed under G.S. 105-134.6(b)(11). It does two things. First, it explains the differences between the deduction for severance wages allowed for tax years 1996 and 1997 and the deduction for severance wages allowed for tax years 1998 through 2013. Second, it answers frequently asked questions about the deduction.
Tax Years 1996 and 1997
For tax years 1996 and 1997, G.S. 105-134.6(b) reads as follows:
- The amount paid to the taxpayer as severance wages as the result of the permanent closure of a manufacturing or processing plant, not to exceed a maximum of thirty-five thousand dollars ($35,000) for the taxable year.
To qualify for this deduction, a taxpayer must receive severance wages resulting from the permanent closure of a manufacturing or processing plant. Severance wages do not include a "stay bonus" paid to an employee notified of an impending termination to encourage the employee to continue to work until a future date. The termination resulting in the severance wages can be voluntary or involuntary. The terminated job resulting in the severance wages can be a job at a location other than the closed plant if the job is terminated because of the plant closure. For example, severance wages received by a taxpayer who was employed in a company's administrative office and was terminated because the company closed a plant and downsized the administrative office due to the closure qualify for the deduction.
A plant is permanently closed when either the plant stops operating or the plant owner sells the assets of the plant to another person who is not an affiliate of the plant owner. The definitions of "affiliate" and "control" in G.S. 105-163.010 apply in determining whether one entity is an affiliate of another. Under those definitions, an affiliate is an entity that controls, is controlled by, or is under common control with another entity. Control is owning more than 10% of voting securities or being a partner or a member of a limited liability company. For example, Company A sells the plant assets to Company B on July 31, 1997. Company B begins operating the plant on August 1, 1997. Company A and Company B are not affiliates. Company A pays severance wages to its employees. These severance wages qualify for the deduction. This is the case even if the employee who receives the wages begins working for Company B on August 1, 1997, with no period of unemployment.
"Manufacturing" is defined in the Standard Industrial Classification Manual issued by the United States Bureau of the Census, and the Department considers manufacturing and processing to be the same. The term includes establishments engaged in the mechanical or chemical transformation of materials or substances into new products and in assembling component parts of manufactured products if the new product is neither a structure nor other fixed improvement.
Tax Years 1998 through 2013
For tax years 1998 through 2013, G.S. 105-134.6(b)(11) provided the following:
- Severance wages received by a taxpayer from an employer as the result of the taxpayer's permanent, involuntary termination from employment through no fault of the employee. The amount of severance wages deducted as the result of the same termination may not exceed thirty-five thousand dollars ($35,000) for all taxable years in which the wages are received.
This deduction differs from the 1996 and 1997 tax year deduction in two significant ways. First, it is not limited to closures of manufacturing and processing plants; severance wages paid due to the elimination of jobs through downsizing or the closing of any type of business qualify for the deduction. Second, it requires an involuntary termination through no fault of the employee. For example, Company A announces that it plans to downsize by terminating 500 employees. It offers a severance package to any of its employees who voluntarily resign from the company and will then identify others who will be terminated if 500 employees do not voluntarily resign. Those employees who resign voluntarily may not take the deduction; those employees identified later by the employer for termination may take the deduction.
Frequently Asked Questions
Q: Is the employer required to withhold North Carolina income tax from severance wages?
Q: How does a taxpayer claim the severance wage deduction?
A: Severance wages are deducted on page 2 of Form D-400 (line 40 of the 1997 return). The taxpayer must provide an explanation in support of the deduction. Employers are encouraged to provide employees with a letter stating the amount of severance wages paid during the calendar year as a result of the termination.
Q: Does a taxpayer who is terminated from a job outside of North Carolina and who then moves into North Carolina qualify for the deduction for severance wages paid after becoming a resident of North Carolina?
Q: If a taxpayer receives $20,000 of qualifying severance wages while a resident and another $20,000 while a nonresident, what deduction may the taxpayer take? (Note: Line references for the example below are for the 1997 individual income tax return)
A: Because the entire amount of severance wages received will be included in federal taxable income, the allowable deduction claimed on line 40 of the return in this case would be $35,000. In determining the percentage of income taxable to North Carolina (lines 42 through 46), the taxpayer must reduce line 42 by $20,000 since that amount was paid while the taxpayer was a resident. Severance wages paid to a nonresident are not taxable by North Carolina even if paid in connection with a job in North Carolina; consequently, neither the income nor deduction should be considered in completing lines 42 or 43. Total income on line 45 should be reduced by the total amount of qualifying severance wages, not to exceed $35,000.
Q: Which of the two versions of the deduction applies?
A: The deduction was originally enacted effective for taxable years beginning on or after January 1, 1996. The deduction was amended effective for taxable years beginning on or after January 1, 1998. Any severance wages paid between January 1, 1996, and December 31, 1997, must meet the requirements of the original statute to be deductible. Severance wages paid on or after January 1, 1998, must meet the requirements of the amended statute. For example, an individual is involuntarily terminated through no fault of the individual on December 1, 1997, from a retail business that is downsizing. The individual receives separate severance wage payments of $5,000 in December, 1997 and January and February, 1998, for a total of $15,000. The severance wages received in December do not qualify for the deduction on the 1997 return because only severance wages from terminations resulting from plant closures qualify for that year. The severance wages received in 1998, however, qualify for the deduction on the 1998 return.
Q: If both spouses receive severance wages that qualify for the deduction, may each spouse claim a deduction of up to $35,000 if they file a joint return or is the total deduction for both spouses limited to $35,000?
A: Each spouse is entitled to a deduction of up to $35,000 for qualifying severance wages received during the taxable year.
Q: For tax years prior to 1998, do severance wages paid as the result of the closing of one division within a plant or as the result of downsizing qualify for the deduction?
A: No. For tax years prior to 1998, the termination of the employees in one division of a plant or the downsizing of some of the employees at the plant does not qualify for the deduction if the plant itself does not close. For tax years 1998 through 2013, the employee is entitled to the deduction if the termination is involuntary.
Q: If an employee is offered a different job with new responsibilities or at a reduced salary and the employee declines the offer and is terminated, is the termination considered involuntary?
Q: If an employer relocates and the employee is terminated because the employee elects not to relocate, is the termination considered involuntary?
If you have questions about this directive, you may call the Personal Taxes Division of the North Carolina Department of Revenue at (919) 814-1066. You may also write to the Division at Post Office Box 871, Raleigh, North Carolina, 27602-0871.