Is Severance Pay Taxed? By Dan Atkerson on May 23, 2020

When an employee is laid off, a severance package is often proposed. A severance package may offer continued pay and/or benefits for an extended period of time. While a severance package can provide financial security following a layoff, it does limit a person’s options in regards to unemployment and, potentially, future employment.

In addition to these concerns, individuals offered severance pay need to consider their tax obligations. Severance lawyer Dan A. Atkerson explains to his Allen, TX clients how severance pay is taxed, so that they understand the tax liability a severance package may involve.

What Is a Severance Package?

A severance package is a set of benefits often offered to employees when a company is issuing layoffs. A severance package may include pay (provided either over a series of payments or in one lump sum), insurance benefits, and/or assistance finding alternate employment. In exchange for these benefits, employers may ask that terminated employees refrain from speaking negatively about the company, or from pursuing litigation.

Severance Pay and Tax Liability

Many of our Plano clients question whether severance pay is taxable. Since the money is received after employment is terminated, some people assume that payments will not be viewed as income. In actuality, severance pay is considered taxable income.

Employees in the United States are required to pay FICA taxes, also known as employment taxes. Under federal law, both employers and employees pay taxes that contribute to Social Security and Medicare. The typical Social Security tax is 6.2 percent, while the typical Medicare tax is 1.45 percent. The United States Supreme Court has ruled that severance pay is subject to these same employment taxes.

There are other tax obligations that may apply to severance pay. In 43 states, state taxes are withheld from severance pay. Additionally, severance pay is classified as a supplemental income, which carries its own tax liabilities. Employers offering a severance package will be required to withhold 22 percent of the payment to be paid to the IRS.

Minimizing Tax Obligations

Depending on the amount of pay provided by a severance package, tax obligations can be hefty for our Frisco clients. While there is no way to avoid taxes, there may be ways to lessen the tax burden, so that it does not have as much of a financial impact. A financial adviser can help individuals determine whether one of these options may be suitable to their financial needs:

Make a contribution to tax-deferred retirement account
Put money into a health savings account for future medical expenses
Open a 529 plan to save for your child’s college expenses, or to pay off your own student debts
Negotiate for your severance pay to be paid out in two separate years, so that tax obligations are divided

Contact Us

If you’ve been offered a severance package, you do not have to accept it “as is.” Attorney Dan A. Atkerson would be happy to look over your severance offer to determine if it is in your best interest to accept the package as offered. To set up a consultation, send us a message at your earliest convenience, or call (214) 743-1387.