Is Severance Pay Taxable?
Severance pay is taxable for the year you receive it and like standard income, your employer will withhold some taxes immediately either as normal wages or as a separate type of pay. With normal wages, there is the normal withholding as completed on your W-4. If severance pay is offered separate from normal wages a flat 22% withholding rate is applied.
What Severance Pay Means For Your Taxes
With severance pay, you may be bumped up to a higher tax bracket if you find immediate employment. The extra income is not the issue, but more money means you face a higher tax percentage hit and get less back and more to social security and the federal and state government entities. If you have a higher income, it may disqualify you for certain income-based credits and/or deductions. Check with your administrator about ways to lower your taxable income. You may be able to apply income to an IRA or HSA, if eligible.
Collecting Unemployment
Depending on the state you live in, you may be able to qualify for unemployment even while receiving a severance. While this is an added financial benefit, both the severance and unemployment income and benefits you receive are taxable. That is why it is important to request tax withholding on your unemployment checks, so you have income applied toward your tax responsibility.
Other Tax Impacts After Job Loss
When you lose your job, you typically lose benefits including health insurance. Many will opt for COBRA for a short time if available, but regardless, termination is a qualifying event. This means for a special enrollment period; you will be eligible for government funded health insurance options through marketplace insurance. With enrollment you may qualify for a premium tax credit that will help pay the higher premiums, if necessary.
Throughout a lifetime there are economic downturns and days of splendor; and when it is down, and layoffs increase hopefully you will have an employer that will be decent enough to offer a severance package. If you are lucky enough to receive a generous package it may help you navigate your financial and tax situation for the coming season.
