When an employee is terminated, they may be offered a severance package. This generally will include pay, extended benefits or both. One common question is whether you will be taxed on severance pay.
The short answer is yes, your severance pay is subject to taxation. It is viewed as wages, and would therefore include the normal withholding and employment taxes that you would see on your regular paychecks.
One common way severance pay is offered is at the time of an employee’s termination. For example, you may have an employment contract which states that you are entitled to severance pay if you are terminated. Keep in mind, while severance pay is not mandatory under law, your employer may offer you it anyways even without company policies or an employment contract in place.
You will be taxed on this pay because it will be viewed as wages. Although this may seem odd since the pay is not for work you performed, you should be aware that you will be taxed on the severance check. Keep in mind that your employer does not need to clearly label the pay as being severance in order for it to be viewed as severance pay.
Additionally, you may also receive severance pay years down the road if you have sued a former employer for wrongful termination. An employer may offer you severance pay after a lawsuit is filed in order to settle the dispute and avoid going to trial. If this occurs, you will still be taxed on the severance pay because it will be viewed as wages earned.
However, if you settle a wrongful termination lawsuit, not all of the settlement may necessarily be viewed as severance pay. Instead, some of the settlement may be viewed as payment for non-wages, such as emotional distress and discrimination. In that event, any non-wage portion of the settlement would not be subject to the same withholdings as severance pay. Instead, it would be reported on a Form-1099.
You should consider contacting an employment attorney or tax attorney if you have any questions about severance pay in general or about how it affects your taxes. A lawyer can explain the terms of accepting severance pay and any tax implications it may have.