Severance pay is taxed as ordinary income by the federal government and most states, with taxes withheld by your employer or paid when you file your return

When you receive severance, the IRS treats it as wages. Your employer must report it on your W-2 form in the year you receive it, and federal income tax, Social Security tax (6.2% up to the annual wage cap), and Medicare tax (1.45%) all explore. The amount you owe depends on your total income for the year, your filing status, and whether you have other income sources.

Your employer typically withholds taxes from your severance check automatically, using the same withholding method they use for regular paychecks. If they do not withhold enough — or if you receive severance in a lump sum that pushes you into a higher tax bracket — you may owe additional tax when you file your return. Conversely, if too much was withheld, you will receive a refund.

State income tax treatment varies. Most states tax severance as ordinary income at their standard rates. A few states — including Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — have no state income tax at all. Some states have special rules for certain types of severance, such as payments for unused vacation or sick leave, though these are uncommon and depend on state law.

Key Takeaways

  • The IRS taxes severance as ordinary wages, and your employer must withhold federal income tax, Social Security tax, and Medicare tax unless you instruct them otherwise.
  • Severance appears on your W-2 form, not on a separate 1099, because it is treated as employee compensation.
  • Receiving a large lump-sum severance can push your income into a higher tax bracket for that year, increasing your overall tax burden.
  • Most states tax severance at their standard income tax rate, but seven states have no income tax and some states have special rules for specific types of severance payments.
  • If your employer withholds too much tax, you will receive a refund when you file; if they withhold too little, you will owe the difference.

How federal withholding works on severance

Your employer is required to withhold federal income tax from your severance check. They use the same withholding tables and methods they use for regular paychecks, based on the W-4 form you completed when you were hired. If you updated your W-4 before leaving — for example, to claim additional dependents or adjust your withholding — that version applies to your severance.

The withholding is calculated as if your severance is a single paycheck for that pay period. If you receive a large lump sum, this can result in withholding at a higher rate than you would normally pay, because the calculation assumes you earn that amount every pay period. For example, if you receive $30,000 in severance in one lump sum and your employer calculates withholding as if you earn $30,000 every two weeks, the withholding will be much higher than if that $30,000 were spread across the year.

You can ask your employer to withhold a specific amount instead of using the standard calculation. This request must be made in writing before the severance is paid. Some employers will honor this request; others will not. If your employer refuses or if you want to adjust your withholding after the fact, you can claim the overpayment when you file your tax return.

Social Security and Medicare taxes on severance

Social Security tax (6.2%) and Medicare tax (1.45%) are withheld from severance just as they are from regular wages. These are separate from federal income tax withholding. Your employer also pays a matching amount (6.2% for Social Security and 1.45% for Medicare), though you do not see this on your check.

Social Security tax has an annual wage cap. In 2024, you pay Social Security tax only on wages up to $168,600. If your severance plus other wages for the year exceed this amount, you will not owe Social Security tax on the portion above the cap. However, Medicare tax has no cap and applies to all wages.

If you worked for multiple employers during the year and your combined wages exceed the Social Security cap, you may have overpaid Social Security tax. When you file your tax return, you can claim a credit for the overpayment. The IRS will refund the excess when you file or explore it to other taxes owed.

State income tax on severance

Most states tax severance as ordinary income at their standard rates. Your employer will withhold state income tax from your severance check using the same method they use for regular paychecks, based on your state's withholding rules and your W-4 form.

Seven states have no income tax: Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you live in one of these states, no state income tax is withheld from your severance, regardless of where you worked.

If you moved to a different state during the year, the state where you worked when you received the severance typically has the right to tax it. Some states have reciprocal agreements that affect this rule, but these are rare. If you are unsure which state should tax your severance, contact the tax authority in the state where you worked or where you lived when you received the payment.

How severance affects your tax bracket

Severance is added to all your other income for the year to determine your tax bracket. If you receive a large severance, your total income may jump into a higher bracket, which increases the percentage of tax you owe on your income above the previous bracket threshold.

For example, if you earned $50,000 in wages during the year and receive $20,000 in severance, your total taxable income is $70,000. If you are single, the 2024 tax brackets show that income between $47,150 and $100,525 is taxed at 22%. Without the severance, income between $47,150 and $50,000 would be taxed at 22%, but income below $47,150 would be taxed at lower rates. The severance pushes more of your income into the 22% bracket.

This bracket effect is one reason why lump-sum severance can result in a higher overall tax bill than you might expect. The withholding your employer takes out may not account for this, especially if the severance is paid in a single check. When you file your return, you will see the full impact and can adjust your withholding for future income if needed.

Reporting severance on your tax return

Your employer reports severance on your W-2 form in Box 1 (wages, tips, other compensation), along with all other wages you earned that year. Severance does not appear on a 1099 form — that would only happen if you were an independent contractor, which is not the case for severance from employment.

When you file your tax return, you enter the total from Box 1 of your W-2 on your Form 1040. The IRS already has a copy of your W-2, so your reported income must match. If you received severance from multiple employers, each will send you a separate W-2, and you add all the Box 1 amounts together.

If you believe your employer withheld too much or too little tax from your severance, you can adjust this when you file. If too much was withheld, you will receive a refund or can explore the overpayment to other taxes owed. If too little was withheld, you will owe the difference when you file.

Special severance situations

Unused vacation or sick leave paid out as part of severance is taxed the same way as severance itself — as ordinary wages. Some states have laws requiring employers to pay out accrued vacation time; others do not. Regardless, the payout is taxable income in the year you receive it.

Severance agreements sometimes include payments for non-compete clauses, confidentiality agreements, or releases of legal claims. These payments are generally taxable as ordinary income. However, certain payments — such as damages for personal physical injury — may not be taxable under federal law. This is rare in severance packages and depends on the specific language of the agreement. If you are unsure whether a particular payment in your severance agreement is taxable, consult a tax professional.

Outplacement services or job search information provided by your employer as part of severance may not be taxable to you if they meet certain conditions. However, if your employer pays you cash to cover these costs, the cash is taxable income. The distinction depends on whether the service is provided directly by the employer or a third party, or whether you receive cash instead.

Frequently Asked Questions

Will I owe taxes on my severance if my employer did not withhold?

Yes. Even if your employer did not withhold taxes, severance is still taxable income. You will owe federal income tax, Social Security tax, and Medicare tax (and state income tax in most states) when you file your return. If you did not have taxes withheld, set aside money to cover the tax bill or make estimated tax payments to avoid penalties.

Can I roll severance into an IRA or 401(k) to avoid taxes?

No. Severance is not may be able to access for rollover to a retirement account because it is not a distribution from a retirement plan. It is treated as wages and is subject to income tax. However, if your severance package includes a lump-sum distribution from your employer's 401(k) or pension plan, that portion may be may be able to access for rollover.

What happens if I receive severance in one year but do not need it until the next year?

Taxes are owed in the year you receive the severance, not the year you spend it. If you receive $30,000 in severance in December but do not use it until January, you still owe taxes on the full $30,000 in the year you received it. Plan your withholding or estimated tax payments accordingly.

Does severance count as income for unemployment benefits?

This depends on your state. Some states reduce or deny unemployment benefits if you receive severance, treating it as income that disqualifies you or reduces your weekly benefit amount. Other states do not count severance against unemployment. Contact your state's unemployment office to learn how severance affects your benefits.

If I move to a state with no income tax after receiving severance, do I still owe state tax on it?

Yes. You owe state income tax in the state where you earned the income (where you worked), not the state where you live when you file your return. If you worked in a state with income tax and received severance there, you owe that state's income tax even if you moved to a state with no income tax afterward.