How do I handle taxes on severance pay and other termination benefits?

Tax Treatment for Severance Pay and Termination Benefits

Severance Pay

- Taxability: Severance pay is considered taxable income in the year that it is received.

- Withholding: Employers are required to include severance pay on the employee's Form W-2 and withhold appropriate federal and state taxes.

- Reference: For more detailed information, refer to [Publication 525, Taxable and Nontaxable Income].

Accumulated Leave

- Taxability: Payments for accumulated vacation or sick time are taxable as they are considered wages by the employer.

- Reporting: These payments will be included in the employee's Form W-2.

- Reference: Additional information can be found in [Publication 525, Taxable and Nontaxable Income].

Unemployment Compensation

- Taxability: State unemployment insurance benefits and extended benefits are taxable.

- Tax Withholding Option: Individuals may choose to have federal taxes withheld from their unemployment compensation by completing Form W-4V.

- Form 1099-G: The state will provide a Form 1099-G by January 31st of each year, showing the amount of taxable benefits paid in the prior year.

- Reference: For further details, see [Publication 525, Taxable and Nontaxable Income].

Gifts from Family or Friends

- Taxability: Cash and property gifts from family or friends are generally not taxable to the recipient. However, if the gift generates income (e.g., interest, dividends), that income is taxable.

- Gift Tax: There is an annual exclusion amount for gifts that do not trigger a taxable event for the giver or receiver. Gifts exceeding this amount may be subject to gift taxes by the giver.

- Reference: Consult [Publication 17, Your Federal Income Tax (For Individuals)] or the [Instructions to Form 709, United States Gift Tax Return] for more information.

Public Assistance or Food Stamps

- Taxability: Public assistance and food stamps are not taxable.

Final Form W-2 from Employer

- Deadline: Employers must provide Form W-2 by January 31st after the close of the calendar year.

- Employer Bankruptcy or Closure: If an employer files for bankruptcy or goes out of business, they are still required to file and report wages and withholding on Form W-2.

- Reference: For issues related to not receiving a Form W-2, refer to [Publication 4128, Tax Impact of Job Loss].

Severance Pay Plans for Government and Tax-Exempt Employers

- Section 457 Plans: Severance pay plans of state and local government and tax-exempt employers are not subject to the requirements of section 457 if they are classified as "bona fide severance pay plans" under section 457(e)(11).

- Benefits: These plans may provide benefits in excess of the deferral limits of eligible 457(b) plans without being subject to a substantial risk of forfeiture.

- Taxability: If a severance pay plan is not a bona fide plan and is subject to section 457(f), then amounts not subject to a substantial risk of forfeiture are currently taxable for income and employment tax purposes.

- Reference: For a comprehensive understanding, review the document [H. SEVERANCE PAY PLANS OF STATE AND LOCAL GOVERNMENT AND TAX-EXEMPT EMPLOYERS].

Reporting Requirements

- Form W-2: Severance payments, accumulated leave, and unemployment compensation are reported on Form W-2.

- Form 1099-G: Unemployment compensation is reported on Form 1099-G.

- Form W-4V: To opt for tax withholding from unemployment compensation, use Form W-4V.

For additional guidance on the tax implications of severance pay and termination benefits, consult the relevant IRS publications and forms mentioned above.

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Sources:

Publication 4128 Tax Impact of Job Loss | Internal Revenue Service 2024-08-03

Publication 15-B (2024), Employer's Tax Guide to Fringe Benefits 2024-08-02

Publication 525 (2023), Taxable and Nontaxable Income 2024-08-03

Publication 15 (2024), (Circular E), Employer's Tax Guide 2024-08-03

H. SEVERANCE PAY PLANS OF STATE AND LOCAL GOVERNMENT AND TAX-EXEMPT EMPLOYERS 2024-07-29

Publication 15-A (2024), Employer's Supplemental Tax Guide 2024-08-02

What if I lose my job? | Internal Revenue Service 2024-08-01

Office of Chief Counsel Internal Revenue Service memorandum 2024-08-02

Tax Implications of Settlements and Judgments | Internal Revenue Service 2024-08-03

Office of Chief Counsel Internal Revenue Service Memorandum 2024-07-31