How severance taxes actually work

The 22% is withholding, not your tax bill#

When your employer cuts your severance check, federal law requires them to withhold a portion and remit it to the IRS on your behalf. That act of withholding is not the same as the tax you owe. It is a prepayment against a liability that gets calculated definitively only when you file your Form 1040. The number on your paystub — commonly 22% for most severance packages — is not a final answer. It is one input into a much larger equation.

The authority for this withholding treatment is IRC § 3402(g), which classifies severance as a supplemental wage and authorizes employers to apply the flat-rate method. Under that method, the withholding rate on cumulative supplemental wages up to $1,000,000 paid by the same employer in the same calendar year is 22%. That rate is set by statute and regulation, not by your W-4, not by your marginal bracket, and not by how much income you’ve already earned that year.

Consider a concrete example. You receive $100,000 in severance. Your employer withholds $22,000 at the flat 22% rate. When you file your return, your total taxable income for the year — including your regular wages, the severance, investment income, and minus deductions — places you in the 24% bracket. Your actual federal income tax on the $100,000 severance is closer to $24,000, not $22,000. You owe the IRS $2,000 more than was withheld. Conversely, if you had a low-income year — laid off in January, minimal other income, large mortgage interest deduction, and dependents — your marginal rate on the severance might be 12% or less, and the $22,000 withheld produces a substantial refund. The 22% withholding rate is the same in both scenarios. The tax owed is not.

The IRS publishes the 2026 supplemental wage withholding rates and procedures in Publication 15-T (Federal Income Tax Withholding Methods). The current flat rate for supplemental wages under $1,000,000 has been 22% since the Tax Cuts and Jobs Act of 2017 lowered it from 25%. That rate is embedded in the withholding tables that employers are required to use, and it has remained unchanged through 2026.

The classic mistake is treating the withholding as a settled tax liability and spending the net check without reserving for a potential true-up at filing. High earners face the bigger risk: a 32% or 35% marginal rate means the 22% flat withholding systematically underwitholds by 10 to 13 percentage points on the severance itself. Middle-income filers may land close to the withholding. Low-income years (laid off early, no spouse income, large deductions) often produce refunds. None of this is visible at the time of the check — it resolves at filing.

The aggregate vs. flat method — and why it matters#

Treas. Reg. § 31.3402(g)-1 establishes two permitted methods for withholding on supplemental wages, and the choice between them can produce dramatically different withholding amounts — especially for higher earners. Most employees have never heard of this choice, but it governs how much federal tax appears on their severance paystub.

The flat-rate method(also called the optional flat rate) applies 22% withholding to all supplemental wage payments below the $1,000,000 cumulative threshold, with no reference to the employee’s W-4. The employer does not look at your filing status, your allowances, or your year-to-date regular wages. The rate is simply 22%. This is the default method for separately identified supplemental wages — when a paystub identifies the line item as “severance” or “bonus” distinct from regular pay, most large employers apply the flat method.

The aggregate methodtreats the supplemental wages as if they were part of regular pay for purposes of computing withholding. The employer adds the supplemental payment to the employee’s most recent regular wages for the relevant payroll period, calculates withholding on the combined amount using the W-4 withholding tables, and then subtracts the withholding already applied to the regular wages. The remainder is the withholding on the supplemental amount. The aggregate method takes into account your W-4 selections — filing status, extra withholding amounts, and so on.

In practical terms: for an employee earning $300,000 per year, the aggregate method would likely produce significantly higher withholding on a $200,000 severance package than the flat 22% method, because the combined income clearly falls in the 35% bracket. The flat method’s 22% withholding would underwithold by approximately $26,000 on that severance amount alone. That gap becomes a balance due at filing.

Some employers allow employees to request the aggregate method, or to submit a revised W-4 specifying additional withholding, before the severance check is issued. If your package is large enough that you anticipate significant underwithholding, it is worth asking payroll whether they can apply additional federal withholding at the source. You can also make estimated tax payments directly to the IRS (Form 1040-ES) to cover the expected gap before the April filing deadline — or the corresponding quarterly estimated payment due dates. Failing to cover the shortfall can trigger the underpayment penalty under IRC § 6654.

IRS Publication 15 (Circular E) describes both methods and employers’ obligations in full. Publication 15-A contains the supplemental tables used for the aggregate method. The choice of method is an employer decision absent a specific employee request — and most large employers default to flat for administrative simplicity.

The 37% bracket kicks in at $1M cumulative supplemental wages#

IRC § 3402(g) establishes a hard threshold: once an employee’s cumulative supplemental wages paid by the same employer in the same calendar year exceed $1,000,000, the flat withholding rate on any amount above that threshold jumps from 22% to 37%. The 37% rate is not a rounding or approximation — it is the top marginal income tax rate for 2026, and the statute requires it to ensure high-dollar supplemental payments are not systematically underwithheld.

The $1,000,000 threshold counts all supplemental wages — bonuses, commissions, signing bonuses, severance, and any other non-regular wage identified separately on a paystub — paid by the same employer within the same calendar year. It is a per-employer, per-employee, per-calendar-year counter. It resets on January 1. A $300,000 cash bonus paid in March and a $750,000 severance package paid in October from the same employer push the cumulative total to $1,050,000. The first $700,000 of the severance withholds at 22% ($154,000), and the final $50,000 withholds at 37% ($18,500). Total federal supplemental withholding on that severance check: $172,500, not $165,000.

The practical relevance for executive-level packages is significant. A mid-year layoff following a strong bonus year can push total supplemental wages well past the $1,000,000 mark. Executives negotiating a severance package should track their year-to-date supplemental wages before signing the separation agreement to understand how much of the new package will be withheld at 37% rather than 22%. That calculation affects both cash flow planning and whether the withholding is sufficient or insufficient for the actual tax liability.

One important nuance: the $1,000,000 threshold and the 37% rate are withholding rules, not bracket rules. Even if the flat withholding on the over-$1M portion is 37%, the employee’s actual marginal bracket on that income might be the same 37% (if total taxable income is very high) or lower (if the package is the primary income event that year and deductions are substantial). The withholding and the tax are computed independently. Use the severance calculator to model your specific scenario.

FICA on severance — Social Security wage base and Additional Medicare#

Severance is wages for FICA purposes. Under IRC § 3121(a), the definition of “wages” subject to FICA taxes encompasses remuneration for employment. The IRS has consistently held that severance paid by reason of employment — rather than, say, as damages in a tort lawsuit — constitutes wages subject to both the employer and employee portions of FICA. The Supreme Court confirmed this in United States v. Quality Stores, Inc., 572 U.S. 141 (2014), holding that severance payments tied to involuntary separation are wages for FICA purposes. Employers must withhold the employee’s share and remit a matching employer share.

The employee-side FICA on severance has three components. First, the Social Security tax of 6.2% applies to wages up to the annual wage base published each fall by the SSA pursuant to IRC § 3121. The applicable wage base for 2026 is the figure published in the SSA 2026 COLA fact sheet. If you have already hit the Social Security wage base from regular wages earlier in the year, no additional Social Security tax applies to your severance — you are already over the ceiling. If you have not yet hit the cap when your severance is paid, Social Security tax applies to the severance up to the remaining headroom.

Second, the Medicare tax of 1.45% applies to all wages with no cap. There is no ceiling on Medicare. A $5,000,000 severance payment faces Medicare tax on the entire amount. Third, the Additional Medicare Taxof 0.9% under IRC § 3101(b)(2) applies to wages above $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately. The employer withholds the Additional 0.9% Medicare Tax only on individual wages over $200,000 — regardless of the employee’s actual filing status or whether a spouse also has wages. Employees who are married filing jointly and whose combined household wages exceed $250,000 but whose individual wages do not each reach $200,000 may owe the Additional Medicare Tax but will not have it withheld; they reconcile that shortfall on Form 8959 at filing.

FICA on severance is not deferrable. Even when severance is structured as salary continuation — bi-weekly payments continuing over 6 months or 12 months — FICA applies in the period the payment is actually received, not when the employment ended. A salary continuation arrangement that straddles a calendar-year boundary (e.g., laid off in November, payments continuing through the following May) means FICA wage-base calculations reset on January 1: payments received in the new year are treated as new-year wages, and the Social Security wage-base clock starts over.

For a concrete illustration: a $300,000 severance paid as a lump sum to an employee who has already earned $150,000 in regular wages in the year would produce Social Security tax only on the remaining wage-base headroom above $150,000, Medicare tax at 1.45% on the full $300,000, and Additional Medicare Tax at 0.9% on the portion of total wages above $200,000 (single filer). The FICA employee-side hit on a large lump-sum severance is not trivial — and it is entirely separate from the 22%/37% federal income tax withholding discussed above.

State supplemental withholding varies wildly — 0% to 11.70%#

Federal withholding is uniform across all 50 states — the same 22%/37% rules apply whether you worked in Dallas or New York City. State withholding is not. It ranges from zero to rates that approach the federal supplemental tier, and the variation can mean a difference of $30,000 or more on a $250,000 package depending purely on your state of employment.

Eight states impose no state income tax on wages at all: Alaska, Florida, Nevada, New Hampshire (I&D tax fully repealed effective January 1, 2025), South Dakota, Tennessee (Hall Tax repealed 2021), Texas, and Wyoming. Severance paid to employees whose principal state of employment is one of these eight states faces zero state income withholding. See our no-income-tax states guide for WARN, UI offset, and non-compete rules in each of those jurisdictions.

California applies a 6.6% supplemental withholding rate on bonus and severance payments as published in the CA EDD DE 44 — applied as the flat supplemental rate on separately stated payments. The CA SDI (State Disability Insurance) employee contribution also applies to wages. California’s top marginal income tax rate is 12.3% (with a 1% Mental Health Services Tax on income above $1,000,000, making the effective top rate 13.3%), but 6.6% is the withholding rate on supplemental wages — not the ultimate tax. Underwithholding is common for high earners in California. See the California severance guide for full detail.

New York applies a supplemental withholding rate of 11.70% for New York State as published in NY Publication NYS-50-T-NYS for 2026, plus an additional New York City withholding of approximately 4.25% for city residents — making NYC the highest combined state+city supplemental withholding in the country for separately identified supplemental wages. New York also imposes a Yonkers surcharge for Yonkers residents. See the New York severance guide for the full breakdown.

Other large-population states: New Jersey applies a flat supplemental withholding rate on separately stated wages per NJ Form NJ-WT (2026); at the top rate, NJ supplemental withholding approaches 11.8%. Pennsylvania applies a flat 3.07% rate on all compensation including severance. Colorado applies a flat 4.4% rate. Ohio uses graduated withholding tables but effectively produces withholding in the 3%–4% range for middle-income severance amounts. Washington has no state income tax. Oregon taxes severance as ordinary income at graduated rates up to 9.9%.

One often-overlooked rule: state withholding follows the state of employment, not the state where you live. If you worked in New York but live in New Jersey, New York supplemental withholding applies to your severance. You may owe NJ tax on the income as your state of residence but receive a credit for taxes paid to New York. Moving across state lines between the layoff date and the receipt of a salary-continuation payment does not retroactively change the source state for wages already earned — and New York in particular aggressively asserts its source rules.

Section 280G — the executive parachute trap#

For executives whose severance is triggered by or contingent on a change in control — typically an acquisition, merger, or other event that causes a change in ownership or effective control of the company — a separate and potentially very costly tax regime applies: the golden parachute rules of IRC § 280G and IRC § 4999. These provisions, enacted in 1984 and amended since, impose a 20% excise tax on the recipient and eliminate the employer's deduction for the excess payment, creating a double penalty that can cost the executive hundreds of thousands of dollars on packages that cross the threshold.

The framework starts with two definitions. A "disqualified individual" is generally any officer, highly compensated employee, or 1% shareholder of the company during the 12 months preceding the change in control — the statute and Treas. Reg. § 1.280G-1 define the boundaries in detail. A "parachute payment" is any payment to a disqualified individual that (1) is contingent on a change in control (or is otherwise accelerated by the change in control), and (2) when aggregated with all other contingent payments, equals or exceeds three times the individual's "base amount."

The "base amount" is the executive's average annual W-2 compensation from the company over the five calendar years preceding the change-in-control year (or the period of employment if less than five years). If your five-year average annual W-2 was $800,000, your base amount is $800,000. The three-times threshold is $2,400,000. If the total of all payments contingent on the change in control — severance, accelerated RSU vesting, bonus continuation, COBRA subsidy, outplacement, accelerated option vesting — totals $2,400,000 or more, the entire arrangement becomes a golden parachute.

Once the three-times threshold is crossed, the "excess parachute payment" — defined as the total contingent payments minus one times the base amount — is subject to the 20% excise tax under IRC § 4999, payable by the executive on top of ordinary income tax. In the example above: if the total contingent payments are $3,000,000, the excess parachute payment is $3,000,000 − $800,000 = $2,200,000. The executive owes 20% × $2,200,000 = $440,000 in excise tax, plus ordinary income tax on the full $3,000,000. The company loses its deduction for the $2,200,000 excess.

Treas. Reg. § 1.280G-1 (a dense Q&A regulation spanning dozens of questions) governs what payments are "contingent on" the change in control. Payments need not be explicitly conditioned on the COC — if the COC accelerates a vesting schedule or triggers a payout that would otherwise have required continued employment, the accelerated amount counts. Non-compete payments made in connection with a COC also count. The regulations contain important carve-outs: reasonable compensation for services actually performed post-COC (supported by a separate independent valuation), payments meeting the small-business exception (the company is not publicly traded and shareholders affirmatively approve the payments in a separate vote), and payments for past services clearly not contingent on the COC.

Three primary negotiation mechanisms address the parachute problem. First, a gross-up provision requires the company (or, post-acquisition, the acquiror) to pay the executive additional cash sufficient to cover both the 20% excise tax and the income tax on that gross-up payment itself — making the executive whole on a net-after-tax basis. Gross-ups have become less common post-2008 due to shareholder and proxy-advisor pressure; they are now rare in newly negotiated agreements except at the most senior levels. Second, a cutback provision reduces the executive's payments to just below the three-times threshold (specifically, to $1 less than three times the base amount) to avoid triggering any excise tax at all — the executive receives less cash but avoids the 20% penalty on the excess. Third, a "better-of" clause directs a computational comparison: pay the executive whichever results in higher net-after-tax value, either (a) the full parachute payment with the 20% excise tax applied, or (b) the cutback payment just below the threshold. The better-of calculation varies materially depending on total compensation and state of residence.

The Section 280G analysis is highly fact-specific and requires an actuarial or tax computation using the actual base-amount calculation, the full list of contingent payments, and the present-value discounting rules in the regulations. If you are an executive whose package is triggered by an acquisition, see our executive severance $1M+ scenario and severance at acquisition / change of control scenario for worked examples and the full 280G checklist.

How to budget around the withholding/owed gap — a worked example#

Abstract principles are one thing. Here is a concrete illustration of how the withholding/owed gap plays out for a real-world scenario — a mid-career professional laid off in Q3, resident and employed in California.

Facts: $250,000 base salary. Laid off in late September. Year-to-date regular wages at time of layoff: approximately $187,500 (nine months of a $250,000 annual salary). Severance package: $250,000 (one year of salary, paid as a lump sum). Single filer, no dependents, standard deduction, no other material income sources. California resident, employed in California throughout.

Federal supplemental withholding on the severance:$250,000 × 22% flat rate (severance is separately stated; cumulative supplemental wages for the year are $250,000, well below the $1M threshold) = $55,000 federal income tax withheld from the severance check. This appears on the severance paystub as a distinct line item. The regular wages from January through September had their own federal withholding applied through the normal payroll process.

Estimating the actual federal liability at filing: Total W-2 income for the year = $187,500 (regular wages) + $250,000 (severance) = $437,500. Under the 2026 federal tax brackets, income in the $200,000–$500,000 range for a single filer sits in the 32% and 35% brackets. The marginal rate on the top dollar of the severance is 35%. This means the 22% withholding — flat, fixed, and W-4-blind — understates the applicable rate by 13 percentage points on that income.

Withholding reconciliation: Regular-wage federal withholding (Jan–Sep, $187,500): approximately $42,000–$48,000 withheld during the employment period via normal payroll. Severance withholding: $55,000. Total withheld: approximately $97,000–$103,000. Estimated actual federal tax on $437,500 of gross income (approximately $422,500 of taxable income after the 2026 standard deduction): roughly $108,000–$115,000. The employee likely owes an additional $10,000–$18,000 at filing. The 22% withholding on the severance fell roughly 13 percentage points short of the 35% effective marginal rate applicable to that income tranche.

California state layer: The $250,000 severance is subject to California supplemental withholding at 6.6% per the CA EDD DE 44 = $16,500 withheld from the severance. California's effective rate on $437,500 of California AGI for a single filer is in the 9%–10% range, implying a CA state liability of approximately $39,000–$44,000 for the full year (including the regular-wage period). The $16,500 withheld on the severance (plus withholding on regular wages during employment) may still leave a California balance due of $8,000–$15,000.

The practical rule of thumb: For earners in the $200,000–$500,000 total-income range, a reasonable planning reserve is 10%–15% of the gross severance set aside in liquid cash to cover the federal and state gap at filing. This varies with filing status, deductions, state, and other income sources — it is only an approximation. Use the severance calculator to model your specific scenario with your income, state, filing status, and deductions. See also our methodology page for the tax assumptions underlying these estimates. Consult a CPA or tax advisor to confirm your position before spending the net check.

Common mistakes — and the less obvious ones#

Mistake 1: Assuming withholding equals tax owed. This is the central error this guide exists to prevent. The 22% on your severance paystub is a prepayment. Your actual liability is computed on your entire year's income when you file. Reserve accordingly, or don't spend the entire net check before April 15.

Mistake 2: Forgetting AMT on ISO exercises in the year of layoff. If you exercise incentive stock options (ISOs) in the same year you receive severance, you create a dangerous interaction. ISO exercises generate an alternative minimum tax preference item equal to the spread between the exercise price and fair market value at exercise. In a layoff year, you may exercise ISOs before the 90-day post-termination exercise window closes, creating a large AMT preference item in the same year you receive a large severance payment — both hitting your return simultaneously. The combined effect can produce an AMT liability that ordinary withholding does not cover at all. See our ISO AMT trap / 90-day window scenario for the full analysis.

Mistake 3: Ignoring state-of-employment vs. state-of-residence sourcing. If you moved states during the year, or if your employer's payroll was set up for a different state than where you actually worked, the source-state rules for wages can produce unexpected tax filing obligations in multiple states. Severance is generally sourced to the state of employment (where you physically performed services), not where you live at the time the check is issued. If you worked in New York for three years and then moved to Florida before negotiating severance, the severance may still be New York-sourced income subject to New York tax. New York aggressively applies its statutory residency and source rules, and wages sourced to New York remain taxable even after the taxpayer relocates.

Mistake 4: Treating all severance components as having the same tax treatment. A single separation agreement often bundles multiple items with different tax characteristics: cash severance (ordinary income, subject to all withholding discussed above), RSU acceleration (ordinary income taxed at vesting), COBRA subsidy paid by the employer (generally non-taxable to the employee under IRC § 106 up to applicable limits), outplacement services (generally employer-deductible, non-taxable to the employee when provided in-kind), and non-compete payments (ordinary income, taxed when received). The negotiation leverage lies partly in the mix: increasing COBRA subsidy or outplacement spend — which are non-taxable to you — rather than additional cash can produce higher after-tax value for the same employer cost. Most people negotiate on the gross cash number and ignore this structure entirely.

Mistake 5: Cashing out a 401(k) to consolidate at the layoff.Taking a 401(k) distribution at the time of separation — if you are under age 59½ — triggers ordinary income tax on the full distributed amount plus a 10% early-withdrawal penalty under IRC § 72(t). In a year when you also receive severance, the 401(k) distribution stacks on top of your already-elevated taxable income, potentially pushing you into a higher bracket and amplifying the effect of both the penalty and the marginal rate. Roll the 401(k) into an IRA or new employer plan rather than distributing it. The 10% penalty alone on a $100,000 distribution is $10,000 in avoidable cost — before counting the bracket impact of the additional ordinary income.

The less visible mistakes often cost more than the obvious ones. High-earning employees who negotiate large packages without modeling the 280G exposure, the FICA hit, the underwithholding gap, and the ISO interaction simultaneously can be surprised by six-figure tax liabilities arriving in April when they expected only a modest balance due. The severance calculator models federal and state withholding; consult a CPA or tax attorney for the 280G, AMT, and multi-state sourcing questions.