Taxes and severance pay: everything you need to know if you’re getting a settlement.

Layoff notices are a common result of economic downturns. It seems like this is happening in droves, particularly in the technological sector. Some people will be relieved since their employers are providing severance compensation.

If this is you, tax preparation may be the last thing on your mind because you’re so stressed out about…everything. While severance pay can be a financial boon in the short term, it’s important to know how your taxes will be affected so you can plan accordingly.

 Find out how to navigate the 2022 tax law changes with the help of a certified CPA in Pembroke Pines, FL.

Can you tax separation pay?

Severance payments are taxable in the year they are received. You must add taxes to the whole amount if you receive three months’ salary.

A portion of your income will be set aside before you get it to cover federal, state, and local tax obligations, just like a regular paycheck. How much you get depends on the terms of the distribution.

There are typically two methods by which employers pay severance:

In addition to your regular pay. This implies that your severance pay will be subject to the same types of withholding (including federal income tax based on your completed W-4, state income tax, Social Security, and Medicare) that were applied to your regular paycheck.

Outside of your regular compensation. Instead of the usual federal income tax withholding that would be determined based on your W-4, a flat withholding rate of 22% would apply.

At the time of termination, your employer may pay you any accrued vacation or sick leave at their sole discretion or as specified in your employment contract. In most cases, the same tax-withholding considerations as those listed above should be applied.

Remember that just because taxes are withheld from your severance pay doesn’t imply you won’t owe any more in taxes. When you submit your tax return, you can calculate that amount. A tax refund or outstanding tax bill is possible, depending on the specifics of your financial status. For peace of mind come tax time, it’s a good idea to see if you need to make any changes to your other withholding sources or submit an estimated payment by seeing a tax professional.