The Tax Shock of Severance Pay

How to Stay One Step Ahead

Losing your job is never easy. And when a severance package lands in your lap, it might feel like a bit of relief, until taxes show up to take their share. 

You’ve worked hard. You deserve to keep as much of that money as possible. But if you don’t plan carefully, that severance could end up costing you more than you expected.

Our business transaction lawyers at Horn Wright, LLP, have helped folks all over New York - whether you’re walking out of an office near Wall Street or hopping the subway from Queens - understand their severance agreements inside and out. 

We’re here to help you keep your money and stay informed. If you're also dealing with related legal questions, like structuring contracts or setting up a new company, our team works closely with commercial contract attorneys and offers access to business formation legal services. 

Whatever your next step looks like, we’ll help you lay the groundwork.

Lump Sum or Installments? Why the Way You’re Paid Could Haunt You Come Tax Time

Severance pay sounds simple. But there’s a catch. It’s all considered income by the Internal Revenue Service. And how you’re paid, whether all at once or over time, can make a big difference in how much you actually get to keep.

Lump Sum Payments

A big one-time payment can feel like a relief. But that lump sum might quietly shove you into a higher tax bracket. The IRS will withhold a flat 22% on that amount for federal taxes alone. Add New York state and city taxes, and you're looking at a serious chunk gone before you ever see it.

Installment Payments

If your employer offers it, taking the payout over time might be a smarter move. By spreading your severance over several months, you could stay in a lower tax bracket and end up paying less overall.

What You’ll Want to Think About

• Tax Bracket Changes: That lump sum could push part of your income into a higher bracket.
• Different Withholding Rates: Installments use your usual paycheck rate, which might work out better.
• Cash Flow Needs: Need that cash right away to cover bills? Lump sum. Want to stretch it out and plan? Go with installments.

Stop the Bleed: Smart Moves to Keep Your Tax Bill from Exploding

You can’t dodge taxes completely. But you can fight back with smart planning. The goal isn’t just to lower your tax bill. It’s to keep more of what you’ve earned. That means taking advantage of every possible deduction, deferral, and timing strategy.

Contribute to Retirement Accounts

Putting money into tax-deferred retirement accounts is one of the easiest ways to reduce your taxable income. It’s not just about long-term savings - it’s an immediate win. Whether it’s a 401(k) or an IRA, these contributions can directly lower your adjusted gross income.

If you have a high-deductible health plan, don’t overlook a Health Care Spending Account (HCSA). Contributions are tax-deductible, the account grows tax-free, and withdrawals for qualified medical expenses are tax-free too. It’s one of the few triple-tax-advantaged tools available.

This year, individuals can contribute up to $4,300 and families can put in $8,550. That’s a solid way to reduce your taxable income while covering healthcare costs.

Time It Right

Timing can be everything. If you’re close to year-end, talk to your employer about pushing part of your severance into the next calendar year. Splitting it can reduce the risk of bumping into a higher tax bracket.

If you’re feeling generous, and want a tax break at the same time, consider donating a portion of your severance to a qualified charity. You may be able to deduct up to 50% of your adjusted gross income depending on the organization and donation type.

This strategy doesn’t just lower your tax bill. It also helps support causes that matter to you. Make sure to keep documentation for everything you give.

Fix Your Withholding

If your severance doesn’t come with enough taxes withheld, you could owe a hefty amount come April. One way to avoid this? Adjust your Federal Withholding Certificate (W-4) immediately or make quarterly estimated tax payments.

Will Severance Kill Your Unemployment Benefits? What Albany Doesn’t Tell You

In New York, if your severance is allocated to a specific period after your termination, it can delay or disqualify you from receiving unemployment benefits during that time. 

The Department of Labor will look at how the severance is structured, whether it's paid as a lump sum or spread out over weeks. If it’s tied to a specific post-employment timeframe, unemployment checks may be paused until that period ends.

Be Honest About It

Always report your severance when applying for benefits. If you don’t, you could face overpayment penalties, interest, and even disqualification. 

Transparency protects you and keeps you compliant with the law. The state has access to wage records, so it’s better to be upfront than deal with the consequences later.

Tips That Could Save You

• Ask How It’s Allocated: Clarify with your employer whether the severance is allocated over time or paid without any strings. This distinction affects your benefit eligibility.
• Talk to NY DOL: Connect with a representative to understand exactly how your payout might impact your claim. Don’t rely on assumptions or hearsay.
• Document Everything: Keep records of severance agreements, communication with HR, and any letters that explain your payout terms. This information can be vital if there's any dispute.

One Payout, Big Consequences: Could Severance Shove You Into a Higher Tax Bracket?

Even if you’re not wealthy, a large severance check can change your tax picture quickly. That sudden increase in income might shift part of your earnings into a higher federal or state tax bracket. This means you’ll pay a higher rate on a portion of your severance than you would on your regular income.

Your Credits Might Vanish

• Child Tax Credit: Starts phasing out once you hit $200K (or $400K for joint filers). A severance package could tip your income just over the line. That makes you ineligible for some or all of the credit, even if you qualified earlier in the year. If you're close to the threshold, consider timing income or deductions to stay under it.
• Education Credits: These include the American Opportunity Credit and Lifetime Learning Credit. They begin phasing out at $80,000 for single filers and $160,000 for joint returns. If your severance bumps you over these limits, you could lose out on thousands in tax savings tied to tuition or school expenses.
• Saver’s Credit: This credit encourages low-to-moderate-income taxpayers to contribute to retirement. But once your AGI passes $36,500 (single) or $73,000 (joint), it disappears. Even a modest severance payout can knock you out of eligibility, so factor it into your savings strategy.

What Can You Do?

• Shift Other Income: If you're doing freelance work or expecting a bonus, consider deferring it into the following tax year. This simple move can help keep you within more favorable tax thresholds. Talk to any relevant payers about flexibility before the year closes.
• Stack Deductions: Itemizing deductions - like mortgage interest, charitable contributions, or state and local taxes - could help lower your taxable income. Timing these deductions during a high-income year amplifies their value. It may be worth bunching two years’ worth of giving into one to exceed the standard deduction.
• Work With a Tax Pro: A professional can look at your entire financial picture and spot tax-saving opportunities you might miss. From identifying obscure deductions to projecting the impact of severance on your adjusted gross income (AGI), they’ll help you make decisions that reduce what you owe and preserve your benefits.

If you're planning bigger moves, like selling or buying a business, we also work alongside mergers and acquisitions lawyers and can offer insight into business sale and purchase agreements.

When severance, unemployment, benefits, and tax brackets all intersect, things get messy and fast. This isn't the kind of situation you want to handle alone or with generic software. 

Why It’s Worth It

Working with a tax professional can be one of the smartest moves you make after receiving severance. They’ll walk through your entire financial situation, making sure your withholding is on target, so you don’t get hit with an unexpected tax bill. 

Instead of trying to decode tax rules yourself, you’ll get real strategies that actually apply to your life and income. Having someone knowledgeable in your corner can also help you avoid costly mistakes and identify savings you didn’t know existed. 

And most of all, they give you something that’s hard to measure but incredibly valuable - peace of mind.

How Local Legal Professionals at Horn Wright, LLP, Can Help

Our seasoned business transaction lawyers at Horn Wright, LLP, have helped New Yorkers make smart decisions about severance, taxes, and the future they’re building. We’ll walk you through it step-by-step. 

Whether you’re fresh off a layoff or making your next career move, we’ve got your back. And if your journey includes forming a new company, changing your structure, or understanding internal controls, we’re here for that too. 

As one of the country’s top law firms dedicated to standing up for people’s rights, we’re ready to support you every step of the way. Call (855) 465-4622 today to schedule your free, no-obligation consultation.