Severance pay is money an employer gives you when your job ends, usually as a set number of weeks of salary. Federal law does not require it: the U.S. Department of Labor says the Fair Labor Standards Act does not call for severance, so it is a matter of agreement between you and your employer. When you do receive it, it is taxed as wages. A 12-week package on a $1,500 weekly salary is $18,000 before tax and about $12,663 after federal withholding at the 22% supplemental rate and Social Security and Medicare taxes, before any state tax.
Here is how packages are usually built, how the tax works and what to check before you sign anything.
Is severance pay required by law?
Not under federal law. The DOL’s guidance on severance pay explains that it is often granted to employees upon termination, but the FLSA does not require it. An employer that has a written severance policy, an employment contract, or a union agreement may be bound by those terms, and some employer severance plans are covered by federal benefit law, which gives you rights to plan documents and a claims process.
Separately, the Worker Adjustment and Retraining Notification Act requires covered employers to give advance notice of certain mass layoffs and plant closings. That law is about notice, not severance, but employers sometimes pay wages in lieu of notice.
How is a severance package usually calculated?
There is no legal formula, but common approaches include:
- One or two weeks of pay per year of service
- A flat number of weeks for everyone at a given level
- A negotiated lump sum for senior roles
Packages may also include continued health coverage for a period, outplacement services, or a bonus payout. In exchange, the employer usually asks you to sign a release of claims.
How is severance pay taxed?
The IRS treats severance pay as supplemental wages, the same category as bonuses. Employers can withhold federal income tax on it at a flat 22% when it is paid separately from regular wages, as long as your supplemental wages for the year stay under $1 million. Social Security and Medicare taxes apply too.
Worked example, 12 weeks at $1,500 a week:
- Gross severance pay: 12 × $1,500 = $18,000
- Federal withholding at 22%: $3,960
- Social Security at 6.2%: $1,116
- Medicare at 1.45%: $261
- Net before state tax: $18,000 − $3,960 − $1,116 − $261 = $12,663
Withholding is not your final tax. The amount is added to your other income on your return; if your actual bracket is lower than 22%, you may get some back, and if it is higher, you may owe more. Check the result with the salary tax calculator.
What about unused vacation and the final paycheck?
Vacation payout is a separate question from severance. Federal law does not require it either, but some states do. In California, for example, the Department of Industrial Relations explains that earned vacation is wages under Labor Code section 227.3 and must be paid out at the final rate of pay when employment ends. The PTO payout calculator estimates that amount, and the final paycheck calculator pulls the last regular wages, vacation and deductions together.
Should you take a lump sum or salary continuation?
A lump sum gives you the money at once and lets you leave cleanly. Salary continuation spreads it over regular paydays, which may keep you on the payroll, sometimes with benefits, for longer. The tax is the same in total, but timing matters: a lump sum paid in December lands entirely in this year’s income, while continuation could straddle two tax years. If you are close to a higher bracket this year, ask whether timing can be adjusted.
What happens to health insurance?
If your employer plan is subject to federal continuation rules, you can usually keep it under COBRA, but you may pay the full premium. Some packages subsidize COBRA for a few months; others do not. Estimate the cost with the COBRA cost calculator before deciding whether severance pay will stretch far enough to cover premiums, and compare against a Marketplace plan.
What should you check before signing a severance agreement?
- The total amount, payment schedule and whether it is gross or net
- What claims you are releasing, and how long you have to review the agreement
- Whether accrued vacation is paid separately from severance pay
- Health coverage terms and the end date of benefits
- Any non-compete, non-disparagement or confidentiality terms
- How the employer will describe your departure to future employers
Workers 40 and older have specific review and revocation periods for releases of age discrimination claims. If the package is large or the terms are unclear, a short consultation with an employment attorney can be worth the cost.
Does severance pay affect unemployment benefits?
It depends on your state. Some states reduce or delay unemployment benefits for weeks covered by severance pay, while others do not count it. Report it on your claim exactly as requested and check your state unemployment agency’s rules rather than assuming either way.
Can you negotiate a better package?
Often you can, especially if you have long service, specialized skills, or concerns about how the layoff was handled. Ask politely and in writing, and be specific: an extra few weeks, a longer health subsidy, an adjusted payout date, or a neutral reference. Employers have more room on timing and benefits than on the base formula. Get every change written into the final agreement before you sign.