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
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 and later. 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 and Later
For tax years 1998 and later, G.S. 105-134.6(b)(11) reads as follows:
- 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?
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
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 and later, 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)733-3565. You may also write to the Division at Post
Office Box 871, Raleigh, North Carolina, 27602-0871.
Last modified on: 10/31/07 03:37:04 PM.