Severance: taxes, timing and the order to do things

Severance is wages. Not a gift, not a settlement for injury, not a loan against anything. That one fact drives every line on the severance stub, and it is the right place to start.

How severance is taxed

Because severance is paid by the employer in connection with your job, IRS Publication 15 treats it as wages, and specifically as supplemental wages when it is paid separately from regular pay. That means:

• Social Security at 6.2% applies, up to the year's wage base.
• Medicare at 1.45% applies, with no cap. An additional 0.9% is withheld on wages over $200,000 in the year.
• Federal income tax is withheld, and for supplemental wages the employer can use a flat rate of 22%. Supplemental wages over $1 million in the year are withheld at 37%.
• State income tax applies in states that tax wages, often with its own supplemental rate.

On a $5,000 lump sum, the federal lines work out like this:

Line	Rate	Amount
Severance		$5,000.00
Federal withholding	22%	−$1,100.00
Social Security	6.2%	−$310.00
Medicare	1.45%	−$72.50
Net before state tax		$3,517.50

Withheld is not owed

The 22% is a withholding rate, not your tax rate. If your actual top bracket for the year is lower, the extra comes back when you file. If it is higher, you owe the difference. A year with a job loss often has lower total income, so it is worth running your own numbers rather than assuming the flat rate is final. The mechanics are the same as for a bonus; see bonus withholding.

Lump sum or continuation

Employers pay severance one of two ways, and sometimes let you choose.

Lump sum. One check, usually withheld at the flat supplemental rate. You have the cash at once, and the employment relationship is cleanly over.

Salary continuation. Your regular pay keeps arriving on the normal schedule for a set number of weeks. Withholding uses your W-4 and the regular tables in IRS Publication 15-T, the same as a normal paycheck. Benefit deductions may keep running too, if the agreement continues coverage.

The total federal tax on the same dollars in the same year does not change between the two. What changes is when the cash arrives, how much is withheld along the way, and, in some cases, which tax year the money lands in. A continuation that runs from November into February splits severance across two years.

The order to do things

Most severance mistakes are sequencing mistakes. Here is the order I would work through.

1. Read the agreement before signing

Severance usually comes with a release of claims and a deadline to sign. Note the deadline, the payment date, whether payment is lump sum or continuation, and whether anything (accrued vacation, a prorated bonus) is paid separately. Federal age-discrimination law gives workers 40 and over specific review and revocation periods in many releases; the agreement should state them.

2. Separate severance from final pay

Your final paycheck (wages through your last day, plus any vacation payout your state requires) is owed regardless of whether you sign. Severance is the extra. See your final paycheck for what belongs on that check.

3. Decide on health coverage before coverage ends

Find the exact date your employer coverage ends. Losing it opens a 60-day special enrollment window for Marketplace coverage, and a COBRA election window as well. The clock starts from the loss of coverage, not from the severance payment. See coverage after a job loss.

4. Check group life and voluntary policies

Conversion and portability deadlines are short. See leaving a job: group life coverage.

5. File for unemployment on time

Severance can delay or reduce benefits in some states and has no effect in others. Filing late can cost weeks regardless. The overlap rules are in unemployment after severance.

6. Adjust withholding at the next job

If the flat 22% plus your new job's withholding will overshoot or undershoot for the year, a fresh W-4 at the new employer fixes it. See the three W-4 boxes that matter.

What to check on the severance stub

• The gross matches the agreement's figure.
• The withholding method is stated, or you can back it out: federal ÷ gross should be 22% on a flat-rate check.
• Social Security and Medicare are present.
• Any 401(k) deferral on severance follows your plan; plan documents differ on whether severance counts as eligible pay.
• Year-to-date totals tie to your last regular stub plus this check.