Losing a job is a fraught experience, to say the least. During those early weeks and months, whether your severance pay is subject to FICA taxes is a question that likely doesn’t immediately register — if ever. In fact, you wouldn’t be alone in assuming that such pay is exempt. Alas, it is not.
Here’s more on that, including information on other pay that is taxed, and steps you can take to handle your tax obligations.
Severance Pay Tax
Although they are not required in most states to make severance payments, many organizations do. Oftentimes it’s simply a goodwill gesture. Other times it’s a way to skirt the risk of lawsuits since employees typically must waive any legal claims against the organization before checks are cut.
Common amounts are one to two weeks’ pay for each year of employment.
As we have established, severance pay in the United States is subject to taxes in the year paid, as are unemployment pay and compensation for leftover sick time and vacation. So, you’ll need to pay taxes on whatever amounts you get.
When distributing pay for severance and sick time and vacation, your employer may withhold necessary taxes automatically.
How is Severance Pay Taxed?
Severance tax is subject to Social Security and Medicare withholding – FICA — as well as unemployment withholding.
Social Security is taxed at 12.4 percent and Medicare at 2.9 percent, with matching amounts paid by the employer. Federal unemployment tax is 6 percent, of which the employer pays the first $7,000.
There is also a flat 22 percent tax rate for withholding for supplemental wages, which the Internal Revenue Service considers severance pay to be.
The amount to pay for state withholding hinges on where you live and what your tax bracket and filing status are.
Note that if you do not have taxes withheld from your unemployment benefits, you’re going to hear from the IRS come tax time.
To learn more about severance pay tax details, check out Freedom Debt Relief.
How to Manage Your Tax Responsibilities
There are some things to consider tax-wise when you’ve lost your job. One silver lining to such loss is that, because your income will likely decrease, you will pay less taxes, even with severance pay and other previously mentioned compensation.
You should also note that while unemployment pay can sure come in handy, you’ll have to face the music at tax time if you don’t opt for voluntary withholding.
Also, maybe you’ve picked up a side gig to bring more cash in. If that’s the case, know that will have to pay self-employment taxes on that income.
Moreover, you may want to think twice about pulling cash prematurely from your IRA or 401(k), since the penalty for early withdrawal is 10 percent.
So, yes, severance pay is subject to FICA taxes, as is some other post-employment compensation, and you know some steps to take when tax planning. If you file your tax return and learn that you owe Uncle Sam due to severance pay, you can deal with the IRS directly or take out a home equity loan to pay what you owe.
If the latter seems too risky because you very well could lose your home, you may want to apply for and use one of those 0% introductory credit cards for paying the IRS. However, if you miss card payments and default, you could be facing overwhelming debt. Should that happen, you may want to consider debt settlement with a reputable, established company such as Freedom Debt Relief.
