Why Is My Severance Pay Taxed At A Higher Rate?

Getting a severance check can feel like a small win during a stressful time. You look at the gross amount and think, “Okay, this will help.” Then you see what actually lands in your bank account, and suddenly it feels a lot less generous.

A big chunk is gone, and your first thought is probably, “Why is this taxed so high?”

That reaction is completely normal. 

Severance checks almost always look heavily taxed, but there’s usually more going on behind the scenes.

In this post, we’ll explain if severance pay is taxed at a higher rate.

Is Severance Taxed At A Higher Rate?

Severance pay is not taxed at a higher rate.

Severance pay is taxed as ordinary income. That means it’s treated the same as your regular wages when it comes to your final tax bill. It’s not some special punishment category. 

Now, could your total tax bill increase because of severance? Yes, that can happen. 

But that’s based on your total income for the year, not because severance has a special higher tax rule attached to it.

Most of the confusion comes from how taxes are withheld, not how they’re ultimately calculated.

Also Read: Can You Go To Prison For Not Filing Taxes?

Why Severance Pay Looks Like It’s Taxed More

If the rate isn’t actually higher, then why does your bank account look so sad? 

It really comes down to how payroll software functions and how the government classifies non-standard checks. Let me explain:

#1 It’s Still “Supplemental Wages”

The IRS considers severance to be “supplemental wages.” That’s the same category as bonuses, commissions, and overtime in some cases.

Employers have a couple options when withholding federal income tax on supplemental wages. A common method is a flat 22% federal withholding rate (for amounts under $1 million). 

That flat rate can feel aggressive if your normal paycheck doesn’t have that much taken out.

The important thing to understand is this:

• 22% is just federal withholding, not your final tax rate
  
• It doesn’t automatically mean you’re in a 22% tax bracket
  
• It doesn’t lock in your total tax bill

It’s simply a standardized way for payroll systems to handle extra pay.

If your normal effective tax rate is lower than 22%, you may get some of that back as a refund when you file your return.

#2 It Gets Lumped Into One Big Check

This one surprises a lot of people.

If your severance is paid as a lump sum, payroll software may calculate withholding as if that big amount is your normal pay for that period. 

And that can inflate the withholding dramatically.

Imagine you normally make $3,000 every two weeks. Then you receive a $15,000 severance in one shot. The system may treat it like you earn $18,000 every two weeks. That pushes the withholding calculation way up, even though that’s not your ongoing income level.

It doesn’t mean you’re permanently in a higher bracket. It just means the software made a short-term assumption based on that single paycheck.

So the withholding jumps. Your heart rate jumps. But your real tax rate for the year hasn’t automatically changed.

Also Read: Can The IRS See My Bank Account?

#3 FICA Taxes Still Apply

On top of federal income tax, severance is still subject to FICA taxes. 

That includes:

• 6.2% for Social Security
  
• 1.45% for Medicare
  
• Possible additional Medicare tax if you’re a higher earner

That’s 7.65% right there before you even talk about federal or state income tax. Add state tax into the mix, and the deductions can feel intense.

People often forget that these payroll taxes apply across the board to wage income, including severance. So when you stack FICA on top of federal withholding, the net number can look rough.

But again, this isn’t a special penalty. It’s the same payroll tax structure that applied to your regular paychecks.

#4 Your Real Tax Rate Is Based On Total Annual Income

At the end of the day, the IRS doesn’t care if you made your money in January or December, or if it came in one check or twenty. 

They just look at the total pile of money you accumulated by December 31st.

If you spent half the year unemployed after getting your severance, your total annual income might actually be lower than usual. 

In that case, that 22% flat withholding was way too high, and you’ll get a nice chunk of that money back when you file your return in April. 

Your “real” tax rate is only determined once all the math is done at the end of the year, so try to view that missing money as a forced savings account that the government is holding onto for a while.

Also Read: My Tax Preparer Lied On My Taxes

When Severance Can Increase Your Total Taxes

Now let’s talk about when severance really can increase your overall tax burden.

Severance adds to your total income for the year. So if that extra income pushes you into a higher marginal bracket, a portion of it will be taxed at that higher rate. 

That’s normal under the tax system.

It can also affect things like income-based tax credits, phaseouts for deductions, premium tax credits for health insurance, and the additional Medicare tax for higher earners.

In those situations, your total tax picture can shift. Not because severance is treated differently, but because your total income changed.

For example, if you were on the edge of a higher bracket and severance pushed you over, part of that severance will be taxed at that higher marginal rate. 

So yes, your total tax liability can increase. But it’s about the math of your annual income, not a special severance rule.

How To Reduce The Tax Impact

Since you likely want to keep as much of that money as possible right now (especially while you’re between gigs), there are a few moves you can make to soften the blow. 

You have to be proactive here, as once the check is cut, it’s hard to undo the math.

Here’s what we recommend:

• Increase contributions to a 401(k) if severance is paid before termination and retirement deductions are allowed
  
• Contribute to a traditional IRA to reduce taxable income
  
• Fund a Health Savings Account if you’re eligible
  
• Time deductions or deductible expenses within the same tax year
  
• Adjust withholding on other income sources to avoid surprises

Planning ahead makes a difference, because even small adjustments can help manage the overall tax picture.

If your severance is substantial, it may be worth running projections with a tax professional. A short planning session can save you stress and possibly money.

Bottom Line

Severance pay isn’t automatically taxed at a higher rate. It just looks that way because of how withholding works for supplemental wages and large lump-sum payments. Add in FICA and state taxes, and the net amount can feel smaller than expected.

Your real tax rate is based on your total income for the year, not on the withholding method used for one check. 

If too much was taken out, you’ll likely see that money again at tax time.

So if your severance check felt shockingly small, take a breath. It’s usually a withholding issue, not a penalty. 

And once everything is tallied up on your return, the numbers tend to make a lot more sense.