Tax Implications of Severance Pay
How to determine when an employee's severance pay is taxable.

Background. Many churches have entered into severance pay arrangements with a pastor or other staff member. Such arrangements can occur when a pastor or staff member is dismissed, retires, or voluntarily resigns. Consider the following examples:

Example 1. Rev. G is hired for a 3-year term at an annual salary of $45,000. After 2 years, the church membership votes to dismiss Rev. G. The church agrees to pay Rev. G "severance pay" in the amount of $45,000 (the full amount of the third year's salary).
Example 2. Rev. C is called by a church for an indefinite term. After 10 years, Rev. C resigns to accept another position. The church board agrees to pay Rev. C "severance pay" of $20,000.
Example 3. Rev. T accepts a call as a pastor of a local church. After 1 year, she is dismissed and is replaced by a male pastor. Rev. T believes that the church was guilty of sex discrimination. The church and Rev. T enter into a severance agreement in which Rev. T agrees to waive any claims she has against the church under state and federal law in exchange for its agreement to pay her "severance pay" of $40,000 (representing one year's salary).

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Posted: October 1, 1995
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