Is Severance Pay taxable?

Severance Pay taxable

The economic downturn has many companies shedding staff, and those workers are being paid severance pay. The tax implications of this money can have long-term effects on your finances, and it’s important to understand them before you receive your final paycheck. You may find that you are pushed into a higher tax bracket, for example, or you may lose some of your favored tax deductions and credits. The good news is that there are some things you can do to minimize Uncle Sam’s bite.

Severance pay is taxable if you are fired, laid off for financial reasons or otherwise terminated from your job. The IRS classifies this compensation as “supplemental wages,” and it is taxable in the year that it is received, just like your normal wages. You also have to pay Social Security and Medicare taxes on it. If you’re a union employee, you may have additional benefits in addition to your severance pay, such as health care and life insurance coverage.

If your severance pay is not enough to cover all of your expenses for the year, consider saving some of it by contributing to a tax-deferred account such as an IRA or 401(k). You can also put money into a health savings account or education IRA if you have one, and you can make charitable donations that are tax-deductible.

Is Severance Pay taxable?

Depending on how much your severance package is, you may want to ask your company to split it up into installment payments that are received in different tax years. This may help you avoid being pushed into a higher tax bracket, and it can give you a chance to use up any remaining pre-tax retirement savings.

The Tax Cuts and Jobs Act of 2018 eliminated some job-loss-related tax breaks, but you can still save on your taxes by using define severance pay to contribute to an IRA or health savings account. You can also use it to donate to charity, but make sure that you have enough other deductions and itemized your return before doing this to get the most benefit.

Some states have different tax rules than the federal government. Check with your state’s Department of Revenue for more information. If you are receiving severance pay as part of an employment dispute settlement, the company might treat it as both severance and non-wage income. This might be because some of the settlement is for damages caused by discrimination or emotional distress, and the rest is for lost wages.

If you’re not sure how to handle your severance payment, talk with an experienced tax professional. The right person can help you navigate your tax situation, plan ahead for the future and make informed decisions about how to spend your money. Sign up for NerdWallet’s thrice-weekly personal finance newsletter to get timely tips and need-to-know deadlines delivered straight to your inbox. By signing up, you agree to our Terms of Service and Privacy Statement. NerdWallet is an independent, for-profit business that provides financial products and tools.

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