Severance Payments Are Taxable

Most people don't want to think about losing their jobs. However, it is best to know the law and to plan ahead just in case you get surprised by bad news. It may come as a shock to hear that severance payments are taxable.

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Employer Linc is a publication about labor laws written to employers. Employees also benefit from understanding employment and labor law. Employer Linc author Paul Ross writes about a disagreement Quality Stores, Inc., had with the IRS.

Quality Stores, Inc., fell on hard financial times just like many businesses when the economy turned sour. They went bankrupt, and because of this, thousands of employees lost their jobs. Quality Stores, Inc. gave severance payments to those employees; the amount of the check varied based upon what the job was and how long the employee had been working for the company. Quality Stores, Inc., treated the severance payments as wages, but instead of making the employees pay the tax, the store paid both the employee and the employer share of taxes on the severance payments.


Later, Quality Stores, Inc. challenged the interpretation of severance payments as "wages." They filed suit to collect the taxes back from the IRS. The bankruptcy court, the district court, and the U.S. Sixth Circuit Court of Appeals all agreed with the company.

The Supreme Court of the United States, however, held that employers deal in wages. Severance payments as well as settlements are included in the definition of wages, and as such, are subject to taxation. This fact affects employees in two ways:

  1. It reduces the amount of potential severance payments and settlements that may be due to you, because employers must calculate in taxes that must be paid; and
  2. You may be the one paying taxes on your severance payments.

On the one hand, any payment is income, even a severance payment. On the other hand, as a governed society we might want to give the newly unemployed the small bonus of at least getting to keep their whole severance payment while they look for their next job.

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