The severance package table (see Table 1) outlines the changing compensation structure for an employee’s separation from a fictitious company, based on years of service and job level. As an entry-level employee with 0-5 years of service, they will be provided a severance package of $5,000, payable in a lump sum upon separation from the organization. A mid-level employee with 6-10 years of service will receive a severance package of $12,000, disbursed biannually with payouts at 6 and 12 months post-separation. As a senior employee with over 11 years of service, they are entitled to the whole $25,000 package, distributed in quarterly installments beginning on their separation date.
This tiered structure offers a fair and equitable approach, recognizing the employee’s sustained commitment and contributions to the company over time. Severance pay is taxable as income by the IRS, subject to standard withholding taxes.
Table 1. Severance package representation
One of the critical ways an employee receives his benefits as he leaves a company is through severance pay, which provides him with a sum of money to help him through the period he is searching for another job. The nature of its administration by both the employer and the employee plays an integral role in determining its tax nature. Severance pay is treated as income and is subject to the same taxes as regular wages. It is therefore applicable to federal and state income tax, as well as FICA taxes, which encompass Social Security and Medicare taxes (Smith & Friedman, 2022).
Employees need to be informed about the tax implications so they do not end up with unexpected tax bills. An increase in an individual’s annual taxable income may arise from severance pay and, therefore, expose one to a higher tax bracket (Alstadsæter et al., 2020). This could result in a larger tax bill or a smaller refund than they might expect. Clearly, such employees should consult a tax practitioner to determine how the severance pay will affect their overall tax position and be prepared for any additional payments it may entail.
Severance pay is taxable because it qualifies as income under United States Internal Revenue Service (IRS) rules. Federal, state, and local taxes are withheld under similar guidelines to those for wages and include Social Security and Medicare (Yakovlev & Leguizamon, 2020). This is because severance pay is a form of compensation for an employee’s past services. Hence, it is taxed the same as his ordinary salary or wages.
The severance package is designed to be equitable and fair, and this aspect is covered by the employee’s level and years of service. It details a structured financial cushion that helps buffer a shockingly sudden loss of employment. From a perspective, severance pay acts as a bridge, giving the employee time to look for other avenues to sustain themselves. This is gross taxable income that should be dealt with in similar ways as other forms of remuneration, both in relation to tax planning and compliance. Both employers and employees must carefully navigate the complexities of tax on severance pay to ensure the transition goes off without a hitch and there are no financial surprises when it is time to file.
References
Alstadsæter, A., Bjørkheim, J. B., Kopczuk, W., & Økland, A. (2020). Norwegian and US policies alleviate business vulnerability due to the COVID-19 shock equally well. National Tax Journal, 73(3), 805-828.
Smith, O., & Friedman, B. A. (2022). The impact of the pandemic on employee benefits. The BRC Academy Journal of Business, 12(1), 1-25.
Yakovlev, P. A., & Leguizamon, J. S. (2020). State taxes and legislative turnover in the United States. Economic Inquiry, 58(1), 518-535.