Why your cheque looks smaller

Severance is taxable income, and the amount that hits your account is smaller than the number in the agreement — often by a third or more. Here's why, and why some of it comes back.

It's a "supplemental wage"

The IRS treats severance, bonuses and commissions as supplemental wages. If it's paid as a lump sum, employers usually withhold federal income tax at a flat 22% (37% on any amount over $1 million). That's withholding — a prepayment — not your final tax bill.

The three bites

• Federal income tax — 22% flat on a lump sum.
• FICA — 7.65% for Social Security (6.2%) and Medicare (1.45%). Severance is subject to FICA.
• State income tax — varies a lot. Nine states take nothing. Some apply a flat supplemental rate; others use tax tables. Our calculator estimates this by state.

Why some comes back

The 22% flat withholding is a blunt instrument. If your total income for the year lands you in a lower effective bracket — common if you're out of work for part of the year — you've over-paid, and the difference comes back as a refund when you file. The reverse is also possible: a large payout on top of a high salary can push you into a higher bracket, and you may owe more in April.

Lump sum vs salary continuation

A lump sum is withheld at the flat supplemental rate. Salary continuation — where the company keeps you on payroll — is withheld like your regular pay, spread across pay periods. The total tax owed is similar; the timing and the paycheck-to-paycheck withholding differ.

Bottom line: the take-home figure is an estimate of what lands now. Your actual tax is settled when you file, and the withholding is a down payment on it.