When you get laid off, you may receive a severance package. If you do, how does this affect your taxes? TaxGlobal is here to help. Let’s take a look.

Is severance pay taxed?

Yes, severance pay is subject to tax in the year you receive it. Just as with your usual paycheck, your employer may withhold some taxes from your severance pay. How much they take out depends on how they give you your severance pay.

Employers usually give out severance pay in one of two ways:

• As part of an employee’s normal wages: in this case, your pay will be subject to all the usual withholdings that apply to your paycheck

• Apart from an employee’s normal wages: in this case, your pay will be subject to a flat 22% withholding rate, which goes to cover part of your taxes

If you’ve accumulated vacation or sick pay, you may also get that money paid out by your employer, according to the terms of the employment contract. That will usually be subject to the same tax withholdings as the scenarios above.

Of course, having taxes withheld from your pay doesn’t mean you won’t owe anything at tax time. You may still owe some money, or you may get a refund if too much was taken out.

Can I collect unemployment if I get severance pay?

You might be able to. It depends on which state you live in, how much severance pay you get, and for how long, among other things. Certain states may only let you collect unemployment if your severance pay has expired.

To find out for sure, get in touch with your State Unemployment Insurance agency. And remember that unemployment benefits are also subject to taxes. Requesting tax withholding when you file for unemployment will make things easier.

How else might my severance pay affect my taxes?

If you get a bunch of severance pay at once, you may jump up into a higher tax bracket. For example, if you get six months’ worth of severance pay in December, you’d be receiving more than a years’ worth of pay in that year. 

If your severance pay does bump you up, not all your income will be taxed in the higher bracket—just the part that goes over that first bracket. 

If your income is higher, you may not be eligible for certain credits and deductions that are income-based. 

In this case, you may want to try and reduce your taxable income by contributing to your HSA or ISA.

How will losing my job affect my taxes?

If you’ve also lost your insurance, you may be eligible to sign up for marketplace insurance during a special enrollment period—which means you may also qualify for the advance premium tax credit, designed to make insurance more affordable for taxpayers.

If you had a Flexible Spending Account (FSA) through your employer, you’ll likely lose that as well when you lose your job.