Unlike a regular paycheck that covers salary for hours worked, severance is viewed as a substitute for wages and, in most cases, is considered supplemental wage income. Some states treat severance the same as federal law and apply a flat withholding rate, while others require employers to calculate the tax based on the employee's highest marginal tax bracket.
Understanding IRS Supplemental Wage Tax Rules for Severance
While this can sometimes lower the supplemental rate, it risks bumping the total income into a higher bracket for that specific pay period. Because of this classification, employers are required to withhold federal income taxes at a specific rate.
The current flat rate system applies a uniform 22% rate to severance payments of $1 million or less, making the calculation straightforward for employers but often resulting in a higher immediate tax than some employees anticipate. The Lump Sum and Annual Tax Reconciliation It is important to understand that the high withholding rate is an estimate, not the final tax bill.
Understanding the IRS Supplemental Wage Tax Rule for Severance
The 22% flat rate is simply the amount pulled from the check and sent to the government upfront. The Shift to Flat Rate Withholding Historically, the taxation of supplemental wages was complex, often requiring employers to aggregate the severance with the employee's regular salary for the pay period.
More About Why is severance pay taxed at a higher rate
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