If you are fired or otherwise let go from your job, you might receive severance pay. That can help you pay your bills while you search for a new job, but like other income, it's generally subject to tax. Severance pay and other lump sum payments often see tax withheld at higher rates than other income.
Severance pay, as well as compensation for unused vacation and sick days, is generally subject to federal income tax as well as Medicare and Social Security tax.
Severance Pay Tax Rate
For tax purposes, most severance pay isn't treated particularly differently from other compensation, so your severance pay tax rate is usually just your regular tax rate. When you get that check or direct deposit pay stub for your severance pay, you can expect to see all the usual taxes withheld, including Social Security, Medicare and federal income tax. If your state has a state income tax, it will typically tax your severance pay at a normal rate as well.
Severance pay, sales commissions, bonuses and other large lump sum payments can boost your tax withholding rate temporarily. This means you'll see a smaller percentage than usual of a paycheck with such a payment, even if you'll get much of it back as a refund when you file your taxes.
For tax purposes, such payments are considered supplemental pay. If you receive more than $1 million in supplemental pay, your employer is required to withhold such pay above $1 million at the highest income tax bracket available for that year. Otherwise, your employer has the option to either pay your supplemental pay separately from an ordinary paycheck and withhold at a flat rate specified by the Internal Revenue Service, or combine the supplement with an ordinary paycheck and withhold at whatever rate IRS tax tables indicate.
Ways to Minimize Severance Tax
You may be able to find ways to reduce your lump sum severance pay taxes. For example, your employer may allow you to spread your severance pay over multiple years, so that it doesn't boost you into a higher tax bracket for a particular tax year, or to contribute a lot of it into a retirement account such as a 401(k).
You may also be able to get an effective severance pay tax deduction by using the money to fund another tax sheltered account, such as an individual retirement arrangement, a health savings account or to pay for tax-deductible expenses such as medical costs if you can arrange to incur them in the same year you receive your severance pay.
Severance Pay Tax Rate for 2019
Your severance pay received in 2019 will generally be taxed according to the usual income tax rates, which have decreased starting with the tax year 2018. Your withholding on a lump sum severance payment will be at a flat rate of 22 percent. If you receive severance pay, bonuses and other supplemental income in excess of $1 million, tax will be withheld at a rate of 37 percent.
Video of the Day
- Department of Labor: Severance Pay
- IRS: Publication 4128 - Tax Impact of Job Loss
- IRS: Publication 525 - Taxable and Nontaxable Income
- Investopedia: How to Minimize Taxes on Severance Pay
- Lorman: IRS Provides Guidance on Proper Income Tax Withholding for Nine Common Supplemental Wage Payment Scenarios
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts and More
- You're Fired - Noise filtered image by Luke Pickering from Fotolia.com