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The IRS view on severance pay

On Behalf of | Oct 10, 2017 | Income Taxes

Some workers receive severance pay from their employer. It may be as the result of being terminated, being laid off or leaving a position. Regardless of why a person received such pay, the IRS views it as wage income subject to tax. Therefore, that payment may be subject to employment taxes and deductions that may apply even if it is received in a settlement years after leaving the company.

In some cases, a settlement may be divided between severance pay subject to payroll deductions and non-wage income. This portion of a settlement would be reported on a Form 1099. How an employer decides to classify a severance payment depends on partially on preference and partially on how seriously it takes its payroll tax obligations. A 2014 Supreme Court decision affirmed that severance pay is subject to employment taxes despite the fact that it could be argued that it is pay for services never rendered.

However, it could also be argued that it should be considered gap pay. Those who receive any form of pay from an employer may be best served by accounting for taxes even payment is not labeled as severance pay. This is because it could be subject to tax if the IRS declares that it looks similar enough to severance pay.

If an individual owes income taxes to the IRS, the agency could take a variety of steps to collect what it is owed. In some cases, it may seize assets or pursue criminal charges. However, the government generally sends notices and levies financial penalties as means of enforcement. Those who are in a dispute with the IRS may benefit from having an attorneynegotiate with the IRS on their behalf.