Tax on Severance Pay

Getting fired or laid off is a terrible feeling. Making it worse, the government requires that you pay taxes on any severance that you are able to collect. This unfortunate circumstance adds insult to injury when you need the income most. However, some mitigating circumstances may allow you to pay less.

Regular Taxable Income

Any severance pay that you receive is considered regular taxable income by the Internal Revenue Service and is accompanied by federal and state income tax for your bracket. In addition, you must pay the withholding for Social Security and Medicare. Income from unused vacation days or overtime is similarly treated as regular taxable income. These might be paid in your last paycheck or in your severance check.

Tax Bracket

When you are laid off from your job and you miss regular paychecks, your income will most likely decline for the year. If that is the case, then your tax bracket may go down and you will be subject to a lower tax rate. However, taxes on your severance are assumed to be at your old income. If this is the case, you will be able to receive some of that money back when you file your tax returns and your tax rate is lower than you were originally assessed.

Possible Unemployment Tax Deductions

Once you have been laid off, you can take tax deductions for some services. You are permitted to take tax write-offs for employment and outplacement agencies, resume preparation, traveling for interviews and other job search expenses. Moving costs for you and your family to pursue a new job are also deductible on your tax returns.

FICA Tax

If you are an employer, you may be wondering whether you are still subject to pay the Federal Insurance Contributions Act (FICA) tax for departing employees. Severance payments are not subject to FICA tax, although the issue has been disputed in the court system. The IRS is expected to continue arguing that employees must pay the tax in these circumstances, so make sure to get a legal opinion on this question from a qualified expert.

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  • You're Fired - Noise filtered image by Luke Pickering from Fotolia.com

About the Author

Kathy Zheng is a personal financial planner. She holds a Bachelor of Arts in economics and is certified as a level 1 financial adviser.

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