Information Center
EMPLOYER TAX BRIEF
Identifying the true cost of terminating an employee
Among the most difficult choices any employer can face is whether to terminate an employee. Beyond the inevitable emotional component, letting someone go has a ripple effect across an organization’s finances, payroll and productivity. Identifying the true cost can help you make more informed termination decisions.
More than a paycheck
The terms “firing” and “termination” are often used interchangeably. However, the financial impact can differ depending on whether the separation is for cause, without cause, voluntary or part of a reduction in force. Each scenario carries its own payroll, benefits and unemployment considerations, which can materially affect your total cost.
It may be tempting to think that the only hard expense of terminating an employee is cutting a final paycheck. But the actual dollar amount can be far higher. Depending on your state’s rules and organizational policies, you may be required to pay out unused paid time off within a certain time frame. Delaying or miscalculating payment can lead to penalties, back-pay claims or legal disputes. Depending on the circumstances, severance or separation payments may also be part of a termination arrangement, further increasing your total cost.
Also, payroll mistakes are common when termination occurs. Payroll staff may be inexperienced with all the details involved. Errors related to withholding, benefit deductions or final wage calculations can necessitate corrections and additional administrative costs. And, again, legal exposure is always in play.
Benefits complications
Employee benefits don’t always end cleanly on an employee’s termination date. You must carefully handle health insurance continuation requirements (commonly referred to as “COBRA”), if applicable, retirement plan updates and any other fringe benefits reconciliations. Mistakes can trigger compliance issues and further strain your relationship with a former employee.
Be extra careful if the employee worked remotely or across state lines. Under such circumstances, termination can invoke other payroll and tax considerations. Final pay rules, reporting requirements and state-specific compliance requirements may differ from those you’re used to — increasing the risk of errors.
Unemployment impact
Many employers are surprised to learn that a single termination can affect their state unemployment tax rate long after the employee in question is gone. In addition, whether laid off or fired for performance-related issues, former staff members may be eligible to file for unemployment benefits — and those claims can also increase your unemployment tax rate. Even if you’re confident that a firing is justified, insufficient documentation can make it difficult to contest a claim.
And the risk rises with each claim filed as it “quietly” raises labor costs and reduces the predictability of your operating budget. This is a big reason why you should always factor financial consequences into every termination decision.
Advisory aftershocks
Sometimes terminations can have surprising cost-related “aftershocks.”
For example, let’s say a former employee files for unemployment benefits six weeks after being fired — long after you’ve put the matter to bed. You’ll need to reassemble the documentation, prepare explanations and communicate with the state agency involved. And if the claim is appealed or requires a hearing, which often happens months later, you’ll have to do even more and get outside advisors involved.
On a similar note, disagreements about final pay, benefits or workplace treatment may simmer for a long time before a formal complaint is filed. At that point, your organization may need help from a payroll specialist or HR consultant. And your attorney should certainly get involved. All these actions are reactive, so the associated costs are largely unexpected. They don’t neatly align with payroll or budget cycles, which can negatively affect cash flow.
Productivity losses
Finally, there’s the most obvious cost of firing: You create a hole in your organizational chart that more than likely needs to be filled. While the role is vacant, remaining employees may have to take on additional responsibilities and work overtime, which can lead to burnout and increase payroll costs. A termination can also negatively impact morale if the decision is controversial.
And there are “hiring” costs, which go way beyond hiring itself. Your staff will need to spend time recruiting, interviewing and choosing a replacement. Then they’ll have to properly onboard and train the individual. Bottom line: Your organization’s productivity will likely take a while to fully recover.
Further exploration
So, does this mean you should never terminate anyone? Not at all. For better or worse, being an employer means you may need to eventually unemploy someone. Just make sure to look at the full picture — including the financial perspective — to determine whether a firing is truly warranted. Contact us for help evaluating the cost impact of any termination decision.