Strategies to Minimize Taxes on Severance Pay
The economic downturn has caused many layoffs across the tech industry, leaving workers with a number of questions about their rights and responsibilities.[0] One such question is whether severance pay is taxable. According to the IRS, severance pay is taxable in the year it was received, and employers will withhold taxes on the payments, which will be included on the employee’s W-2.[1] While severance pay is considered ordinary income, there are several strategies that can be used to minimize the tax burden.
If the severance is received in a lump sum, it may be eligible for capital gains tax treatment, which would mean a lower tax rate than regular income.[2] Additionally, severance pay can be spread out into multiple payments across two different calendar years, which would help keep the taxable income lower for each year.
For those who receive severance pay, contributing some of it to an individual retirement account (IRA) or a health savings account (HSA) can help reduce the tax bill. These accounts will allow the money to grow tax-free. Additionally, contributing to a 401(k) may be an option if the employer allows it.[1]
Overall, severance pay is taxable, but there are strategies to minimize the tax burden. Contributing to an IRA, HSA, or 401(k) can be an effective way to reduce the amount of taxes owed. Additionally, strategically spreading out the tax liability across multiple payments across two different calendar years can be beneficial.
0. “What to know about severance pay amid more layoffs” Townsville Bulletin, 31 Jan. 2023, https://www.townsvillebulletin.com.au/news/world/what-to-know-about-severance-pay-amid-more-layoffs/video/9bbbb95de69d496f5bdd19817bd58fa7
1. “Is Severance Pay Taxable? Affects of Job Loss on Your Taxes” Market Realist, 3 Feb. 2023, https://marketrealist.com/taxes/is-severance-pay-taxable/
2. “Taxes 2023: What Does a Layoff Mean for Your Tax Filing?” GOBankingRates, 30 Jan. 2023, https://www.gobankingrates.com/taxes/filing/taxes-2023-what-does-layoff-mean-for-your-tax-filing
