The IRS just published a new ruling in June, Revenue Ruling 2008-29, defining severance pay as “supplemental” income.
Supplemental income is taxed at a higher rate(currently 25%) than regular wages. So if you were working and have been laid off, and you were losing ~15-25% of your regular wages to the Federal taxman, because you have W-4 deductions and such, you’re now going to be losing 32% or so of your severance pay. 25% Federal income tax, 6.2% to Social Security, and 1.45% to Medicare.
You’ve been laid off, you were lucky enough to get a severance package, so you’ve got something to live off of while you job hunt. It’s not a windfall, it’s just your regular pay for some period of time. Plus your expenses probably just went up because you’re going to have to pay for your insurance, maybe through COBRA, and you want to save as much as possible to make your package stretch in case you have trouble finding work quickly. Reasonable under the times we live in. Instead the IRS declares your severance package is “supplemental income” and takes 25% off the top for Federal Income taxes. No allowing for your W-4 setup or other deductions. Just 25% off the top. No matter how much or how little you earn, or how many mouths you have to feed. For most people, especially working families, this will mean the withholding for Federal taxes is far higher than it was.
For some people the income really is supplemental, those who were lucky enough to get a job right away and have two paychecks, one of which was severance. For those who weren’t so lucky, they’ve got less to live on while they try to find work. Nice job IRS.
I know it is cold comfort now, but you do get the “extra” tax back when you file, don’t you? In other words, it is a higher level of withholding rather than a higher actual rate on the severance package - I seem to remember that is how it worked on my bonus checks in the past.
The one way I always saved money in between jobs was by taking advantage of the COBRA back paying situation, if it is still in effect. I think you used to be allowed to not pay the premiums, but if you needed coverage for a particular reason during the eleigibility period, you could back pay the premiums to that point and be covered. Not sure if that was wishful thinking on my part or if it has been changed, but I believe it was the case.
I’m not American so forgive my ignorance on the subject, but how is a higher taxation rate for supplemental income justified? That is, how do they justify it when your normal income tax rate is already a floating percentage based on your total yearly income in the first place? It sounds like double dipping.
Yes, this is just withholding. The final taxes are calculated on your whole year income, including deductions and credits. Basically the IRS is making people give them interest free loans at a bad time. They’ve been laid off, their financial security isn’t that great, so go ahead and take an extra 10-15% of their income(depending on which tax bracket they were in). Taking a 10-15% reduction would break a lot of families living paycheck to paycheck. Families which otherwise may have been able to make the transition from one job to another with just the severance package now have to do it on even less.
The only reason I can see to do this is if you think a lot of people are double-dipping, getting a severance package from one company and regular wages from another, and only withholding W-4 levels from both. These people basically had their income double, but when income doubles, income taxes more than double(because they’re progressive), and they’re only being taxed at double rates(and allowing for double deductions/exemptions, etc.). Those people will not have enough withholding to cover their tax liability at the end of the year. Taking extra from these people would make sense, if there is a way to identify them.
What I think isn’t really fair is applying it to everyone, regardless of if they have a new job or not. If someone is living, and supporting a family, off of a severance package they can’t really afford to have it cut by 10-15% while they job hunt. Not only will it cover less of their ongoing bills, it means they have less they will be able to stretch if their job hunt runs beyond their package length. I presume the first thing people will cut will be their insurance(can’t afford COBRA when you’ve taken a pay cut).
It’s just a little thing which seems thoughtless, doesn’t seem to solve any real problems, and which will strain many working families. So why do it? You’ll get your extra money from the double-dippers at the end of the year, why penalize everyone now?
But if you are ‘double earning’, getting severence and working another job, this will come out when you file and you don’t have enough withheld and you pay come April 15th.
What’s really fucked up, if you ask me, is that unemployment is subject to federal and state tax. Oh and in NY, the state doesn’t take any out of your check, it just asks for it back come April.
I mean, not to be a dick or anything, but severance tends to only exist with really white collar jobs where you’re (presumably) making enough to have built up a “rainy day” fund and have a nest egg while also drawing reasonably from unemployment while you look for a new job. Most workers should be so lucky as to get a severance!
That’s not a legitimate reason, either – the IRS still gets its full pound of flesh at the end of the year (and collects penalties if they haven’t been getting close-enough amounts during the year).
Yup. And if I have to sell stock or cash out options, I am going to be fucked again.
Glad you have a sense of humor about this. I am trying to keep mine, but it is not easy.
Yes, severance can be perceived as a white collar luxury. I do not believe it is for a few reasons.
First, it is part of my compensation. It is an inducement for me to stay with my company rather than jump ship to another for a little more cash. I am not high enough up on the food chain to come in to a company with seniority.
Second, there is no union for white collar corporate hacks.
Third, it is probably going to take me a lot longer to find a new job in my field that I can do than a worker whose product is more commodified. My field is kind of specialized and technical: the upside is that I make more money, the downside is that I fill more of a niche. Unfortunately, my niche is in consumer credit, which right now, is not such a great place to be. If I get cut this year, getting a new job that can meet my minimum mortgage/maintenance/student loans/food minimum is going to be a real bitch.
Because companies want to encourage specialization, they induce people to specialize by providing a minimal safety net for them if things contract.
When I worked for the feds (not the IRS) whenever we received a bonus federal taxes were withheld at the current maximum rate, regardless of what the withholding rate was for your regular salary. When you added in withholding for state taxes and FICA, this would take quite a bite out of it. Knowing that you might get some of that back when you filed your return wasn’t much comfort, particularly when you got the bonus in January or February.
Absolutely. And it sucks eggs. I had a solid bonus in 2007 paid out in Feb of this year, and the witholding was painful. So I just rescheduled my yearly accountant visit to the first week in February. If I lose my job in October, I want my refund quicker than boiled asparagus.
Many people who get severance packages aren’t in what you might think of as the upper income brackets. I used to work for a large multinational bank - if tellers or admin assistants were laid off, they got severance packages. I wouldn’t necessarily say that a receptionist supporting kids is going to be able to sock away a ton of savings on her salary.
If you qualify for emergency withdrawal of 401K earnings they take 30% directly from the amount. Never mind if you have almost no income and will not owe 30% next year. you won’t see 30% of that emergency money for up to a year.
That’s absolutely the case. Your employer has up to 30 days to inform the plan administrator of the qualifying event (the termination of your coverage, which may or may not be the same as your actual termination date), the administrator has up to 14 days to send you the paperwork, you have 60 days after that to elect coverage, and finally you have 45 days after the election to actually pay your first premium. So you could conceivably have up to 149 days after your coverage termination (depending on the speediness of the employer and administrator, of course) before you actually need to pay a penny in order to be covered. Of course, at that point you need to pay for the entire amount going all the way back to your coverage termination. However, often the most sensible thing to do is to wait until the very last minute to elect, and then hold off paying as long as you can. With any luck, you’re employed somewhere else by then, and you can just not pay and the administrator will cancel the coverage going all the way back.
I think you are reading it wrong. There is a difference between mandatory flat rate withholding, optional flat rate withholding, and the aggregate procedure.
*"If the supplemental wages paid to an employee by an employer (as defined in the regulations) during a calendar year do not exceed $1,000,000, then the amount of income tax withholding is determined under the rules provided in § 31.3402(g)-1(a)(6) and (7). These paragraphs describe two procedures for withholding on supplemental wages: the aggregate procedure and optional flat rate withholding.
An employer applies the aggregate procedure described in § 31.3402(g)-1(a)(6) by using the withholding tables applicable to the payroll period with respect to which the employer is calculating the income tax withholding liability on the supplemental wages. The supplemental wages, if paid concurrently with wages for a payroll period, are aggregated with the wages paid for such payroll period. If not paid concurrently, the supplemental wages are aggregated with the wages paid or to be paid within the same calendar year for the last preceding payroll period or for the current payroll period, if any. The amount of tax to be withheld is determined as if the aggregate of the supplemental wages and the regular wages constituted a single wage payment for the regular payroll period.
The aggregate procedure can be used to determine the amount of income tax to be withheld with respect to any payment of supplemental wages, except to the extent that mandatory flat rate withholding applies. See § 31.3402(g)-1(a)(6) of the regulations. However, optional flat rate withholding may only be used under certain conditions. "*
DrDeth, any chance of getting that in layman’s terms? The best I can get out of it is “your employer may choose to apply withholding rates which take into account the W-4 if your supplemental wages are less than 1,000,000.” To which I say “or they may choose a much less labor intensive flat rate withholding.” Given that you’ve already been laid off, they have no incentive to make their payroll department jump through extra hoops to calculate an appropriate amount of taxes with the aggregate method, odds are they’re going to flat rate withhold. I know that’s the choice my former employer made.
Oh, and to make matters better, the Feds ruling that severance packages are “supplemental income” triggers a lot of states to also tax them at “supplemental” tax rates. So both the Federal and State income tax withholding on severance packages are likely to be higher.