Tax on Severance
Employee is negotiating a serverance with company. Scenario is not a lay off but mutual agreement to separate. Lump sum serverance will be provided. What are the income tax consequences of this scenario?
Employee is negotiating a serverance with company. Scenario is not a lay off but mutual agreement to separate. Lump sum serverance will be provided. What are the income tax consequences of this scenario?
Permalink Submitted by Al Fry on Mon, 2008-11-03 18:38
Fully taxable as ordinary income.
Permalink Submitted by Clyde Wolf on Mon, 2008-11-03 18:45
Doctorid63,
Alfry is right. But as such, if the exiting employee is receiving a reduced severence because they will have outplacement services, the value of the outplacement services can be deducted as a Schedule A Miscellaneous Deduction subject to the 2% of AGI.
Permalink Submitted by Alan Spross on Mon, 2008-11-03 19:57
In this situation, unless employee is moving to a much higher paid position, it is best to try to negotiate a roll out severance or even a roll out to a given date followed by a lump sum for the remainder.
Since many firms want the salary off the books by year end, this may be impossible, or may violate the severance plan as described in the SPD. However, a late year severance, particularly if it is a full year or other long period is very costly from a tax standpoint because the W 2 income for 2008 could be close to double what was expected.
In addition, a lump sum severance may provide for 20% or some other withholding figure which may prove to be inadequate to cover the tax liability, so it may be wise to have the 2008 tax bill estimated before year end so there are no surprises.
Permalink Submitted by Anne Schulze on Mon, 2013-11-04 19:46
Have you heard of a qualified severance plan in which the lump sum distribution is eligible for a direct rollover to an IRA to avoid the tax liability? I’m being told by a client this is allowed, but I’ve never heard this before. He says the qualified severance plan is covered under the IRC 401(a) rules.
Permalink Submitted by mk foss on Thu, 2013-11-07 19:30
I have never heard of this either. If it is a qualified 401(a) plan, a rollover is available but generally severance is not paid from a plan of any kind.