A congressional report has revealed that the FTC is probing Elon Musk’s mass layoffs at Twitter, just one of many across the American workforce over the past several months as companies struggle with inflationary pressures and an uncertain economic environment. For some employees, a severance package can often soften the blow and provide a bit of a financial cushion until they land another job. But that cushion may also soon deflate, as the Internal Revenue Service (IRS) treats severance packages as wages, which in turn, affect taxes.
What’s more, the additional taxable income might put some workers in a different and higher tax bracket. The IRS explained that not only severance pay and unemployment compensation are taxable, but payments for any accumulated vacation or sick time, too.
Severance pay is taxable in the year that you receive it, meaning that your employer will include this amount on your Form W-2 and will withhold appropriate federal and state taxes. As for annual leave, vacation pay and sick pay, they are calculated as wages by your employer and will be included in your Form W-2, according to the IRS.
Another important point when it comes to lump-sum severance payments is that the employer can choose to pay it in two ways. The first option would be as part of your normal wages, which means that all the normal withholding — federal income tax based on your completed W-4, state income tax, Social Security and Medicare taxes — that applied to your paycheck will also apply to your severance payment, according to H&R Block.
The other option involves the employer choosing to pay it apart from normal wages — in which case, a flat 22% withholding rate for federal income tax (in place of the normal federal income tax withholding that would be calculated based on your W-4) would generally apply, H&R Block noted.
One tip is to try to negotiate with your employer to have periodic payments instead of a lump-sum payment. “If opting in for periodic payments, chances are you’ll keep (get the use of) more of your money as you need it during the year instead of having to wait until you file and the IRS processes it to get your money back -and it may not be as much as you’d expect,” said Tatiana Tsoir, CPA, business expert and founder of The Bold Blog.
Tsoir added that some employers might take that route, as it is more attractive for them — usually, the employee is prevented from filing for unemployment benefits during that time.
Whether you can negotiate or not with your employer depends on a variety of factors, but Tsoir noted that HR usually tells an employee how it’s going to work. “Rarely do employees have a choice in the matter. And the reason is that different states approach large layoffs differently,” she said. “Some impose restrictions and sanctions on businesses and so if a business can mitigate by stacking, or scheduling unemployment benefits applications, they will be very strategic about it.”
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