Severance pay is monetary support included in a benefits package that employees typically receive upon termination or layoff. The payments help workers transition from their position and stay afloat while looking for their next job.
The knowledgeable employment law attorneys with Joseph & Norinsberg have deep experience negotiating severance packages and helping clients like you understand the tax implications of their benefits. On this page, our team will explain how severance pay is taxed and how to keep more of your compensation.
How Is Severance Pay Taxed?
Severance pay is considered taxable income both under federal and New York State law in the year that you receive it. The pay is not regarded as exempt income and is not treated as a gift. It may even be subject to municipal taxes, such as New York City’s local income tax.
How Is Severance Pay Taxed at the Federal Level?
The IRS classifies severance pay as supplemental wages, meaning all standard employment-related taxes apply to it. Severance pay is subject to:
- Federal income tax withholding
- Social Security tax
- Medicare tax
- Federal unemployment tax
Employers either withhold federal taxes on supplemental wages at a flat 22% rate—which increases to 37% after the first million—or use the “aggregate method,” combining the bonus income with regular wages and taxing the total amount as normal. For severance pay, employers using the aggregate method will likely include the severance payment in the worker’s final paycheck.
What Are Common Tax Deductions for Severance Pay?
Because severance pay is considered taxable income, tax credits and deductions will typically apply to reduce what you owe. The standard deduction will reduce your taxable income from severance pay, but if you expect a higher tax burden, methods you can use include:
- Contributing to a tax-advantaged account, such as a traditional IRA
- Donating to a charity, if you are itemizing your deductions
- Spreading payments over multiple tax years, if taking your whole payment at once would push your income above a higher taxation threshold
Does Severance Pay Affect My Ability to Get Unemployment Benefits?
Severance pay can reduce your eligibility for state unemployment benefits. In New York, you cannot receive unemployment while receiving severance payments worth more than the state’s weekly maximum benefit rate, which is currently $869. If you received a lump sum payment, your prorated severance income must be lower than the maximum benefit rate.
You may be eligible for unemployment benefits if your severance payments are below the maximum benefit rate, you did not receive any severance pay for at least 30 days after your last day at work, or you remain unemployed after your severance ends.
How Does a Higher Income Affect How Severance Pay Is Taxed?
When added to your other annual income, your severance pay might push you into another marginal tax bracket. This change means a portion of your income could be taxed at a higher rate. The federal tax rate rises alongside your total income, but each threshold only applies to the portion of your income that exceeds it.
For example, Stephanie earns $190,000 per year before taxes. Her tax rate in 2025 will be 24% for the income she makes above $103,350. However, if she is laid off and offered a severance package of $50,000, her highest tax rate becomes 32% for any income above $197,300. Stephanie would owe $13,664 in tax on the income in the highest bracket.
However, if the severance were split over two years instead, Stephanie would only owe $5,664 on the $17,700 in the highest tax bracket. Assuming she makes the same amount next year and the tax rates stay the same, Stephanie could save $2,336 by taking her severance pay in installments.
How Do You Negotiate Severance Pay with Tax in Mind?
If you take a lump sum severance payment, there’s a chance that your income could rise above the next tax bracket. Employers are often open to packages where severance is paid in installments, allowing you to spread your tax liability over multiple years to avoid owing more than necessary.
You can also reduce your tax liability by using your severance pay to contribute to a traditional IRA. You likely won’t be able to use your severance to contribute to an employer’s 401(k) before separating from the company, but there are scenarios where this might be possible.
If tax liability is a significant concern, you can negotiate for other benefits in your severance package instead of extra compensation, including extended employer health care benefits or job search assistance. An experienced employment law attorney can help you understand your options.
Contact Joseph & Norinsberg For Your Employment Law Cases
With over 100 years of collective experience in employment law, the skilled lawyers at Joseph & Norinsberg are committed to protecting the rights of workers like you. If you have questions about how severance pay is taxed, contact us online or call 212-227-5700 for a free consultation.
