Can Severance Pay Be Tax Free?

Severance Pay Be Tax Free

Losing a job is always stressful, but the financial blow can be compounded by an IRS surprise. Severance pay is money companies give to employees who are laid off, and it can vary from a lump sum to regular payments following a set schedule. While employers are not required to offer severance packages, many do so as an act of goodwill.

When it comes to taxes, severance pay is taxed just like any other income you receive. Your employer will withhold federal and state income taxes, social security and Medicare taxes, federal unemployment insurance tax and more. If you’re receiving a large lump sum, the amount of withholding will be significantly higher than on a regular paycheck. This can cause you to jump into a higher tax bracket, and it can prevent you from taking advantage of certain income-based deductions and credits that you may have been able to claim while working.

Typically, the only way to avoid paying a lot of taxes on severance pay is to spread it out. If your company is willing to do this, it’s a great option. You can even ask your company to stagger the severance package so that it’s not all paid in one year, which will reduce the amount that is added to your income and tax bracket.

If you have an employment contract, it’s possible that your severance package will be tax-free. But the rules on this are quite different than those for non-employees.

Can Severance Pay Be Tax Free?

Most people who are laid off are not in a position to negotiate the terms of their severance package, and it’s up to your former employer to decide whether or not to include it in your final settlement. This is why it’s important to know what you can and cannot expect from your employer when it comes to severance package benefits.

Severance pay is typically taxed at a flat rate of 22%, regardless of whether it’s in a lump sum or in regular installments. However, the exact amount you’ll owe at tax filing time will depend on your total income for the year and the taxes withheld from other sources, such as wages, interest earnings and capital gains. If you’re worried about the impact of define severance pay on your taxes, it’s often best to consult with a professional who can provide personalized advice. H&R Block offers a free, live chat feature that can connect you with a knowledgeable representative for personalized support.

If you can’t afford to pay for a professional, consider signing up for a NerdWallet account for access to a one-hour, previously recorded webinar on how to file your taxes. NerdWallet is an independent, unbiased financial resource that helps you make smart decisions about your money. Sign up for a free account or sign in to watch on demand. NerdWallet’s free webinars can help you prepare for tax season and get your finances in order. You can also check out NerdWallet’s thrice-weekly personal finance newsletter, which covers topics from investing to credit cards.

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