Severance pay formula for small business layoffs: what to offer, and the rule that voids it

The formula most US small businesses land on is one to two weeks of base pay per year of service, with a two to four week floor so a short tenure employee is not offered almost nothing. No statute sets that number. The only two severance formulas published anywhere in US law, the New Jersey and Maine statutes, both use one week per year of service, which is why one week is the anchor and anything above it is negotiation. The part that actually decides whether the money buys you anything is not the multiplier: it is whether the payment is additional to what you already owed, and whether you are laying off one person or two.

Severance in a small layoff is not really a compensation decision. It is a purchase. You are buying a signed release of claims, and the price is set by what the release is worth to you rather than by any market standard. That reframing matters because it explains the two mistakes that turn a well-intentioned package into a payment that bought nothing at all, and both of them show up more often at companies under 200 people than at large employers with a standing RIF playbook.

Why there is no standard formula to look up

The Department of Labor is unusually blunt about this. Its severance pay page states that there is no requirement in the Fair Labor Standards Act for severance pay, and that severance pay is a matter of agreement between an employer and an employee. There is no federal minimum, no federal formula, and no federal schedule by tenure or level. Any figure presented to you as the standard is somebody's policy that got repeated often enough to sound like a rule.

Two states are the exception, and both landed on the same number. New Jersey requires one week of pay for each full year of employment in a covered mass layoff, plant closing or transfer of operations, and Maine requires one week's pay for each year, and partial pay for any partial year, after a covered closing or relocation. Both statutes reach employers at 100 or more employees, so a genuinely small business is usually outside them. What they give you is the only published benchmark in US law, and it is why one week per year is the floor most policies build from rather than the ceiling. The full picture of who is covered, and what happens when a layoff crosses a state line, is on the severance pay and severance packages page.

The formula, and the three decisions inside it

The arithmetic is trivial. Annual base salary divided by 52 gives a weekly base rate. Multiply by the weeks granted per year of service, then by years of service. A $78,000 salary is $1,500 a week; at two weeks per year with six years of service, that is $18,000. The reason severance schedules still go wrong is that three decisions sit inside that formula and most policies never write them down.

Write all three down before the first layoff, not during it. A severance schedule drafted in advance is a policy. The same schedule drafted the week you need it is a set of individual decisions, and individual decisions are the ones that have to be explained later.

The two person rule that catches small employers

This is the single most expensive thing on this page. Most small employers know that an employee 40 or over gets 21 days to consider a severance agreement and 7 days to revoke it. Far fewer know that the 21 days applies only to an individual separation, and that the threshold for the stricter set of rules is two employees.

The regulation is 29 CFR 1625.22(f)(1)(iii)(B), and it says a program exists when an employer offers additional consideration for the signing of a waiver pursuant to an exit incentive or other employment termination, giving a reduction in force as the example, to two or more employees. Once it is a program, an employee 40 or over must be given a period of at least 45 days within which to consider the agreement, and the employer must hand over a written disclosure covering the decisional unit, the eligibility factors, the time limits, and the job titles and ages of all individuals eligible or selected for the program, and the ages of all individuals in the same job classification or organizational unit who are not eligible or selected.

Read that against how a small layoff actually happens. Two roles get eliminated in the same week, both people are over 40, and both are handed the same one page agreement with 21 days on it. The multiplier was generous, the tone was decent, and the ADEA waiver is invalid anyway, because the consideration period was wrong and the age disclosure was never produced. The 7 day revocation period is equally rigid: the regulation states it cannot be shortened by the parties, by agreement or otherwise. Whether a given termination is even eligible for these deadlines depends on getting the underlying employment relationship right in the first place, which is a separate question covered on 1099 vs W2 classification.

What you already owed does not count

The second mistake is quieter and costs the whole release. A waiver is valid only where the employee receives consideration in addition to anything of value to which the individual already is entitled. Final wages are already owed. In states that treat accrued vacation as earned wages, that balance is already owed. Commission that was earned before the termination date is already owed. A severance policy you published in the handbook is already owed.

So a package built as "four weeks, which includes your PTO payout and your last commission check" is arithmetic that looks generous and legally buys you very little, because the part that is genuinely additional may be a fraction of the headline number. Pay what you owe as what you owe, on its own line, and make the severance a separate figure sitting on top of it. Because the answer turns on the state's own definition of wages at termination, and those definitions vary more than employers expect, it is worth checking how your state's courts have actually read the term before you decide whether a PTO balance is discretionary or owed.

Budget the payment, not just the multiplier

Severance is a supplemental wage. If it is identified as a payment separate from regular wages you may withhold a flat 22 percent for federal income tax, and IRS Publication 15 says no other percentage is allowed for that method. It stays wages for social security, Medicare and FUTA, which the Supreme Court confirmed unanimously in United States v. Quality Stores for severance paid to involuntarily terminated employees. The practical consequence is that the employer side of FICA rides on top of every severance dollar, so a $60,000 severance line is not a $60,000 cash requirement.

One structural choice is worth making deliberately. A lump sum is usually cleaner for a small employer than salary continuation, because a one time payment triggered by a single event requires no ongoing administrative program, which is the distinction the Supreme Court drew in Fort Halifax Packing Co. v. Coyne between writing a check and operating a benefit plan. Salary continuation also runs into state unemployment allocation rules more often, since some agencies assign the payment to the weeks it covers and delay benefits accordingly.

A worked example: three roles at a 40 person company

Assume a policy of two weeks per year of service, a four week floor, prorated to the month, base salary only, and no tiering. Three roles are eliminated in the same week.

Total severance is $27,000, plus employer FICA on all of it, plus any accrued vacation owed separately under state law. Two of the three are 40 or over, so this is a program: both of them get 45 days and the written age and decisional unit disclosure, and the 29 year old coordinator gets neither because the ADEA does not reach her. Note also what the floor did. It moved the analyst from three weeks to four and the coordinator from roughly one week to four, which is exactly the compression a floor is for, and it is far easier to defend than deciding case by case that the short tenure people should get "something".

Notice obligations are a separate question

Severance and layoff notice are different duties and small employers routinely merge them. The federal WARN Act reaches employers with 100 or more employees, so a 40 person company is outside it, but several states run their own thresholds and New Jersey's version carries the severance mandate itself. Getting the headcount test right matters before you assume you are clear, and the counting rules are covered on the WARN Act notice requirements page. Severance also does not usually offset WARN damages when it is owed under a policy or conditioned on a release, so a package cannot be treated as a substitute for notice you were required to give.

The number under the formula still has to be right

Every severance formula on this page multiplies a base salary. If the base is wrong, so is the severance, and a layoff is the worst possible moment to discover that two people doing the same job were paid differently for reasons nobody wrote down. That gap becomes visible precisely when a group of departing employees compare their agreements, and under the program disclosure rules they are handed the job titles and ages of everyone selected anyway. Current, documented salary bands built from published US wage data are what make the base defensible before the multiplier ever gets applied, and the same federal wage data that supports a job posting range supports a severance schedule applied across a group.

Sources: US Department of Labor, Severance Pay; 29 CFR 1625.22(d), (f) and (e); N.J.S.A. 34:21-2; 26 M.R.S. 625-B; IRS Publication 15; United States v. Quality Stores, Inc., 572 U.S. 141 (2014); Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987). This is general information about published law, not legal advice. Severance turns on your own facts and your own state, so confirm the package with employment counsel before you send it.