Issuing Final Payments in the Workplace

April 24, 2013

By Wade W. Herring II

Originally published by SHRM in HR Topics and Strategy. Used by Permission.

HR professionals must execute many tasks when employees leave the company by choice or are terminated. One of the most important items to get right is final payments to departing employees.

Be Big in Small Things

Some companies dock final paychecks for excess sick days, uniform violations or other inexpensive missing property. The late Malcolm Maclean, former mayor of Savannah and accomplished attorney, advised his clients and colleagues, “Be big in small things.” A company is best served if it avoids a penny-wise and pound-foolish reckoning with the departing employee.

When an employee leaves, the process should be as amicable as possible under the circumstances, and always professional. Good employees should depart on a positive note, since former workers serve as ambassadors for your organization and your brand. Satisfied “alumni” will continue to be friends with and referral sources for their ex-employers.

Even when an involuntary departure is triggered by a rule violation or performance problem, err on the side of graciousness and generosity. The goal is to minimize the risk of legal liability, not to provide the departing individual with another reason to file an administrative claim or lawsuit.

Federal Law Governing Final Payments

The last paycheck should include compensation for all time worked. Best practices discourage extraordinary deductions from final paychecks, while the Fair Labor Standards Act (FLSA) prohibits such deductions from overtime pay. Additionally, nonexempt employees must be paid at least minimum wage for all regular hours worked.

Exempt employees’ final paycheck should not reflect extra deductions for discipline or property violations. If an employee’s last week is less than a full workweek, however, the FLSA allows organizations to prorate the final paycheck and cover only days worked.

Whether an employee is exempt or nonexempt, the FLSA does not require employers to immediately issue the final paycheck; rather, they may wait until the next regular payroll.

Importance of State Law

Usually, federal law pre-empts state law. Even so, with wage-hour law, when state law is more generous to employees, as a general rule, state law governs. Thus, some states require immediate payment. In California—one of the strictest states in the nation when it comes to final-payment rules—final checks must be given upon termination or within 72 hours if the worker resigned. If an employee has given more than 72 hours’ notice, the check must be presented immediately.

By contrast, employer-friendly states such as Georgia, Florida, Alabama and Mississippi have no laws regulating final payments when an individual is dismissed or quits. Accordingly, businesses in these states may wait until the next regular payroll after an employee’s separation to issue the final paycheck.

Violating state laws on final payments, even out of ignorance, can be costly for employers. In some states, if an employer fails to pay a departing worker within the legal time requirements, it may have to pay additional penalties and interest, along with any attorney fees and legal costs the employee incurred in seeking payment.

Vacation Time and Sick Pay

The FLSA does not determine whether unused vacation time or sick leave should be included in the final paycheck. Once again, state law governs.

In some states, including California, accrued paid time off is considered part of earned compensation and must be included in a last payment. In other states, such as Georgia, company policy governs.

In states where an employer is able to set its own rules, an employee handbook is an ideal place to specify whether unused vacation time or sick pay is earned and payable to exiting employees. Legalistic distinctions based on “for cause” terminations are ill-advised. Remember: The goal is to have the employee exit as gracefully as possible, not to create more causes for controversy.

Severance Pay and Release Agreements

Severance—a payment in addition to what the employee is entitled to receive under the law and the company’s own policies, procedures and benefit plans—provides the departing individual with extra assistance upon leaving the company and allows the employer to obtain, in return, a release of claims (meaning an agreement not to sue the employer for more compensation).

For the release to be valid, severance pay must provide extra compensation or other in-kind considerations beyond what the employee would ordinarily receive. If the severance check is simply the final payment for time worked, it does not qualify as severance pay. Thus, final paychecks are typically issued before severance payments.

Before the 2008-09 Great Recession, a common severance formula was one week’s pay for every year of service—capped at 12 or 15 weeks of severance. Since the recession, however, employers have reduced severance to smaller amounts. As long as the severance is extra and not an entitlement, it can provide for a release of claims.

Like final paychecks, severance payments are subject to withholding for taxes. The rules about FICA are in dispute because of differing circuit court rulings.

To be clear, certain kinds of claims cannot be released, such as FLSA, workers’ compensation and unemployment benefits claims. A release cannot prohibit an employee from filing a charge with the Equal Employment Opportunity Commission. Nevertheless, a release can preclude the ex-employee from benefiting financially, even when a charge is filed. As a practical matter, a valid release extinguishes most federal, state and local claims.

The Older Workers Benefit Protection Act (OWBPA) governs the requirements of an effective release for age-discrimination claims. The Age Discrimination in Employment Act protects workers who are 40 and older. Special rules apply for group layoffs, but for an individual separation the release agreement must:

Give the employee 21 days to decide whether to sign and seven days to revoke after signing.

Advise the employee of the right to consult with an attorney.

Specify that released claims include age discrimination.

Even employees younger than 40 should be allowed time to review an offered severance-and-release agreement and to consult with an advisor. An organization that demands that the employee sign immediately probably does not have a valid release, but such insistence does not allow the employee to make a knowing and voluntary decision. In the eyes of the law, a demand to sign immediately is coercion.

When severance is offered and accepted, departing workers should not remain on the employer’s group health care plan, since, by definition, former employees do not meet the eligibility requirement of employment. Rather, exiting individuals should be offered COBRA coverage. Part of the severance may include payment of the COBRA premium or reimbursement for COBRA premiums for a certain period.

Parting may or may not be sweet sorrow, but separations can be stressful for everyone involved. Use checklists, plan ahead, and lose the emotion. Make the tough decisions, but execute the termination plan with professionalism and respect.

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