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Voluntary Separation Incentives

State Controller Technical Guidance

Effective Date: 07/01/2025

Approved by: Robert Jaros, CPA, MBA, JD, Colorado State Controller

Authority

  • U.S. Code, Title 26, §61, 104 (Internal Revenue Code)
  • IRS Publication 525 (2004), Taxable and Nontaxable Income
  • IRS Publication 15 (2025), (Circular E), Employer’s Tax Guide
  • 2007
  • CRS § 8-4-101(14)(a) &(b) Colorado Wage Act
  • CRS § 24-19-103 (2024) Prohibition against postemployment compensation – exception
  • CRS § 8-24-51-101 (42)(b) Definitions
  • PERA – Retroactive Payment, Settlements, and Awards, S-139 (Rev 8/17)
  • Office of the State Controller CORE Federal Tax Reporting Guide
  • State Personnel Board Rules, Post Employment Compensation Rule 3-51 to Rule 3-54.

Background

The Office of the State Controller (OSC) is providing this guidance to assist agencies regarding taxability and withholding for voluntary separation incentives and separation payments.

Definitions - IRS Code and Related Concepts

  • Wages - IRC § 3401(a) defines Wages as all remuneration for services performed by an employee for his/her employer.  Generic term for Disputed Wages, Back Pay, Front Pay, or Relinquishment of Tenure Rights.
  • Wages - CRS § 8-4-101(14)(a) & (b) includes all amounts for labor or services performed by employees.  Wages or compensation do not include severance pay.
  • Withholding - When the State pays Wages, the State withholds federal, state, and Medicare tax.  The State does not withhold these taxes when making payments that are not Wages.
  • Voluntary Separation Incentives– A discretionary financial payment offered to more than one certified employee as a means of encouraging the employees to leave state service in order to avoid or minimize the impact of a layoff.  Voluntary separation incentives are offered at the Executive Director’s discretion and are allowable within available funding.
  • Severance Pay - A discretionary financial payment that may be offered to a certified employee as a means of encouraging the employee to leave state service in order to avoid or minimize the impact of a layoff. Severance is offered at the Executive Director’s discretion and is allowable within available funding.

Technical Guidance

  • Voluntary Separation Incentive Plan and Agreement
    • Agencies and institutions of higher education must have a Voluntary Separation Incentive Plan approved by the agency executive director or president.
    • Agencies and institutions of higher education must use the form of the Voluntary Separation Incentive Agreement prepared by the Office of the Attorney General.
  • Taxes and Withholding
    • Taxes and Withholding are the same for both Voluntary Separation Incentives and Severance Pay.
    • Voluntary incentive payments, such as those offered through a Voluntary Separation Incentive Program (VSIP), and severance pay are:
      • Considered taxable income.
      • Subject to federal, state, and local income tax withholding, as well as Social Security and Medicare taxes (FICA – Federal Insurance Contribution Act) and FUTA (Federal Unemployment Tax Act).
      • Treated as supplemental wages, similar to bonuses or other cash incentives.
  • PERA
    • PERA 24-51-101(42)(b) defines salary, or compensation for services rendered, that is PERA-eligible. The state’s voluntary separation incentive payments and severance payments are not considered “salary” under PERA, because voluntary separation incentives or severance payments are not offered for services that were rendered.
    • Since the voluntary separation incentive and severance payment are not considered salary, they are not PERA-eligible.
  • FAMLI
    • FAMLI premiums apply to and are deducted from wages.  Voluntary separation incentive payments or severance payments do not qualify as wages under the Colorado Wage Act, and therefore, neither qualify as wages under FAMLI.
    • Since FAMLI premiums are deducted from wages, and incentive or severance payments do not qualify as wages, FAMLI premiums are not withheld in incentive or severance payments.
  • Payroll Codes
    • CSV - used for voluntary separation incentives and severance payments and settlement agreements with disputed pay or front pay.  W-2 reportable.  Not PERA-eligible salary.
    • BCK – used for back pay in settlement agreements.  W-2 reportable.  PERA-eligible salary if meets criteria for back pay.  See OSC Settlement Agreements and Taxation Technical Guidance.