Updated: April 1, 2026
If you are laid off or fired from your job or quit, you may be entitled to severance pay. You may also receive a severance package if you sue or settle with a company.
Severance checks can come months and, in some cases, years after an employee has left a company, opening up questions about whether such payments are subject to taxes.
So, is severance pay taxable? What is the severance pay tax rate? And are there any ways to reduce severance package taxes?
Is severance taxable? In short, yes. But to gain a fuller understanding, let’s start with the fundamental question: what is a severance tax?
Severance checks, along with unemployment compensation and payments for accrued sick days and vacation time, are all considered taxable income under IRS regulations. This means they are subject to withholding and employment taxes just like any other paycheck.
If you receive your check on exit, you may find that severance pay taxes have already been accounted for, along with other regular payroll deductions. If your severance pay comes later down the line as a gross check, you are required to report it when you file your tax returns. Either way, severance pay tax is an unfortunate inevitability.
So, exactly how is severance pay taxed?
The IRS classifies severance pay as supplemental wages for income tax withholding. Taxes are due in April of each year, although it’s sometimes possible to apply for an extension until October.
You should expect deductions to cover Social Security and Medicare Tax, Federal Unemployment Tax, Federal Income Tax, and State Income Tax:
Social security tax is charged at 12.4% and split equally between the employee and employer at a rate of 6.2% each. Social Security taxes fund retirement, disability, and survivorship programs regulated by the Social Security Administration.
Medicare tax is charged at 2.9% and split equally between the employee and employer at a rate of 1.45% each. Medicare taxes fund hospital, hospice, and nursing home costs for disabled and elderly Americans.
Your employer pays federal unemployment tax at a rate of 6% on the first $7,000 paid to each employee as wages during the year. Unemployment tax funds are allocated to state unemployment insurance agencies and used to provide benefits to people who are out of work.
Deductions are based on your tax bracket and filing status. For the 2025-2026 tax year, there are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. The thresholds for income tax vary depending on whether you are:
State withholding tax also varies by tax bracket and filing status. States with the highest income taxes (above 10%) include California, New Jersey, and Hawaii. However, there are currently seven that do not assess income tax at all:
You can typically receive your severance as either a lump sum or a periodic payment, but you should know the tax implications before deciding.
Lump-sum severance payments can be appealing, since they give you immediate access to your full severance pay and you can use it to pay down debts or invest it. That said, a lump-sum payment can also bump your total income into a higher tax bracket.
Conversely, periodic payments can spread your severance across multiple tax years, reducing your tax liability. Receiving your severance pay over a longer time period can also create a sense of financial stability, as you'll still be receiving money regularly.
Severance pay can affect your tax refund, increasing or decreasing it based on your total income, withholding, and filing status.
Sometimes employers withhold a higher percentage of severance payments since they are taxed as supplemental wages, which can result in a larger tax refund.
Like lump-sum payments, unemployment benefits and severance pay can also increase your total income and push you into a higher tax bracket. This could disqualify you for certain credits and deductions, reducing your refund or even causing you to owe taxes.
Although it’s impossible to avoid severance package tax altogether, there are a few tactics you can employ to minimize your contributions.
Staggering your severance pay relieves the burden of a one-off payment. Plus, spreading out your payments could lower your tax bracket and tax rate.
Making contributions to a health savings account (HSA) is a great way to reduce your tax burden and simultaneously save for future medical expenses. HSAs are pre-tax accounts, and the current contribution limit stands at $3,850 for individuals and $7,750 for families.
You can contribute up to $7,000 a year to an individual retirement account (IRA), and your money isn’t taxed until you withdraw it when you retire. Other options include paying into a Roth IRA (which taxes you for contributions but not withdrawals) or contributing to your employer’s 401(k) plan.
Putting severance payments into a 529 plan allows parents to save and pay for their children’s education. Specific regulations vary by state, but 529 earnings are not subject to federal or state income taxes.
Severance pay is subject to federal, state, and payroll taxes, but how much you ultimately owe depends on how you negotiate severance pay, your total income, and the strategies you use to manage it.
Porte Brown's team of tax professionals can help you navigate your severance pay package and make informed decisions. Contact us today.
Severance pay is taxed as ordinary income, but your employer may withhold federal income tax at a higher severance tax rate. While this could result in you receiving a higher tax refund, your actual tax liability will depend on your total annual income, filing status, and how your severance is paid out. You may also owe state income taxes, depending on where you live.
Yes, any income you earn must be reported to the IRS, including severance pay. If paid through your employer's payroll system, severance will typically be included on your W-2 form. If you received the payment after leaving the job, you'll still need to report it.
You generally can't avoid paying taxes on severance pay, but you can reduce how much you owe with careful planning. Strategies like contributing to tax-advantaged accounts and opting for periodic payments over a lump sum can help keep you in a lower tax bracket.
If your income is in a lower bracket, you may also qualify for deductions or credits. Working with a qualified tax professional can help you structure severance pay to avoid overpaying.
Get in touch today and find out how we can help you meet your objectives.
