The notification of layoffs is a common response to economic downturns. Especially in the IT industry, it seems like this is happening right now in droves. For some, the bright spot is that companies are still providing severance payouts.
If this sounds familiar, you’re probably stressed out about, well, everything, and your taxes may be the last thing on your mind. However, planning for the future and getting ahead of the next tax season by knowing how your severance payment will be taxed is a good idea.
Do not worry; tax professionals for small businessescan address the most often-asked questions (and maybe some you haven’t even thought of) about severance packages. If you need assistance with your tax return, H&R Block is there for you.
Is a severance package taxable income?
Severance pay is taxable the year you receive it. That means you’ll have to add taxes to your three-month salary if you get a bonus.
In the same way that taxes are deducted from a regular paycheck, your employer will do the same. How much you get depends on the method of distribution.
There are two common methods that companies employ to pay severance:
With the rest of your regular pay. To put it another way, your severance payout will be subject to the same types of withholding (Federal income tax based on your completed W-4, state income tax, Social Security, and Medicare taxes) that were applied to your regular salary.
Outside of your regular compensation. If this is the case, instead of the usual federal income tax withholding that would be determined based on your W-4, a flat withholding rate of 22% would apply.
Depending on the circumstances and the provisions of your employment contract, your employer may pay you any accrued vacation or sick leave upon termination of employment. In most cases, the same tax withholding considerations as previously applied.
Note that just because taxes are withheld from your severance compensation does not necessarily mean you owe no taxes. While preparing your tax return, you will perform the necessary calculations. It’s possible you’ll either have a tax bill to pay or a refund to get. Getting in touch with a tax professional to determine if you need to change other withholding sources or make an estimated payment can help you avoid unpleasant surprises come tax time.