Severance pay tax: How losing a job impacts your taxes in 2026

What is severance pay?  

Severance pay is compensation employers may give to employees who have lost or left their job. It is common, but not required, for a company to offer severance due to layoffs.

The amount of severance that employees receive depends on many different factors. The financial strength of the employer, how long the employee has worked there, the number of layoffs, the type of work the employee does, the salary of the employee, and industry norms all come into play.

To you, severance may feel like a lifeline, obligation, or insult, among other things. The IRS only sees it one way: as taxable income.

How severance pay is taxed

All severance pay is subject to federal, state, and local taxes, as well as Medicare and Social Security taxes. These taxes are typically removed from your paycheck in the form of tax withholding. The tax rate depends on how your former employer categorizes your severance pay.

• Tax on regular wages: If your employer treats your severance as regular wages—essentially an extension of your regular paycheck—your W-4 form will determine how much money is withheld for taxes.
• Tax on supplemental wages: If the company reports your severance supplemental income—like a bonus, commission, or overtime—22% is withheld, regardless of how much you get or what it says on your W-4.

Lump-sum severance vs. periodic payments

Employers typically pay severance either in one lump sum or as periodic payments (often on the same schedule as a paycheck). For example, if your severance agreement is eight weeks of pay, you could get one big lump-sum check or receive smaller individual checks on a regular two-week pay schedule for a couple of months.

More money is withheld from lump-sum severance treated as normal wages.

If your company opts to pay your severance as regular pay, withholding is based on your W-4 and assumes you receive roughly the same amount of income every paycheck. When the paycheck gets bigger, withholding rises to match what is assumed to be the new, ongoing pay rate. Therefore, a lump-sum severance check looks like a raise and withholding goes up accordingly. (This can seem unfair, but that’s the way it is.)

Withholding is lower when your severance comes in periodic payments as regular wages.

The exact rate of withholding depends on your W-4. It will generally be the same as it has been on previous paychecks.

When severance comes as supplemental wages, 22% of your pay is withheld regardless of whether you receive a lump sum or periodic payments.

How will severance pay affect my tax refund?

It depends. Although you might rather have a job than a bigger tax refund, in some cases severance can lead to the IRS owing you more money at the end of the year.

For example, let’s say you got a lump-sum severance payment as regular wages. That could mean a lot of money was withheld from the check. But you also lost your job and steady paycheck, so your annual income could very well end up lower than originally expected. In that scenario, where your total withholding increases while your total income declines, you could be owed a bigger refund.

On the flip side, a severance payment can boost your annual income unexpectedly—imagine getting a check for six months of severance in October, when there are only three months left in the year. If that happens, you may end up owing more in taxes than expected. You may even need to make an estimated income tax payment to avoid penalties later.

The timing of your severance can affect your taxes as much as how much money you receive does. A Jackson Hewitt Tax Pro can help you sort it out long before the tax deadline. 

How to minimize taxes on severance pay

You might be able to reduce the impact of severance pay on your taxes by making a few smart moves before the tax deadline.

• Contribute to a tax-deductible IRA. Severance pay is not eligible for tax-advantaged contributions to employer-sponsored retirement plans like a 401(k) or 403(b). However, you might qualify for extra tax deductions when you use the money to contribute to a traditional IRA. If you are married and filing jointly, you could make a contribution for your spouse, too.
• Make charitable donations. If you have enough tax deductions to make itemizing deductions worthwhile, or you’re close to the standard deduction amount, giving some of your severance pay to charity can have tax benefits, too. If you take the standard deduction, charitable donations don’t affect your taxes.
• Pay Spring tuition in December. The Lifetime Learning Credit is a non-refundable credit of up to $2,000 (per return) for qualified tuition, fees, and educational expenses. The American Opportunity Credit applies to qualified education expenses for the first four years of higher education for eligible students. If you use severance money to pay next Spring’s first quarter tuition in December , you may be able to claim these credits on your current tax return. 

Tax Pros at Jackson Hewitt are around all year to help you figure out whether it makes sense to use your severance to claim these tax deductions and credits. Who knows? You might even decide to become a Tax Pro. The end of one job is a chance to begin a new one.

About the Author

Jo Willetts, Director of Tax Resources at Jackson Hewitt, has more than 35 years of experience in the tax industry. As an Enrolled Agent, Jo has attained the highest level of certification for a tax professional. She began her career at Jackson Hewitt as a Tax Pro, working her way up to General Manager of a franchise store. In her current role, Jo provides expert knowledge company-wide to ensure that tax information distributed through all Jackson Hewitt channels is current and accurate.

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