Q: Was I overtaxed on my severance?
I was terminated from my employment and signed a severance agreement with my employer. The amount listed in the contract was 3 months severance minus standard payroll deductions & withholdings. However, when I received the lump sum severance amount and reviewed deductions, I was taxed over 40% on the severance (I only belong to the 22% tax bracket & the severance doesn't change this). My standard tax deductions and withholdings normally only amount to 18%. This severance is not being considered or taxed as supplemental wages by the employer. Is this amount of taxation legal?
A:
In California, severance pay is often treated as supplemental income by the IRS and is subject to federal withholding rates. If your employer did not consider it as supplemental wages, it's important to understand how severance pay is taxed. Severance pay can be taxed at a higher rate initially due to the way lump sum payments are processed by payroll systems, which might explain the discrepancy you're seeing.
The standard federal withholding rate for supplemental wages, such as severance pay, can indeed be higher than your regular income tax rate. For amounts over a certain threshold, the IRS mandates a withholding rate of 22%, but this does not preclude additional state taxes, Social Security, Medicare, and other possible deductions. If your severance was taxed at over 40%, it could include these additional taxes and contributions.
It might be beneficial to consult with a tax advisor or an attorney who understands employment and tax law. They can review the specifics of your severance agreement and your tax situation to determine if the withholding was appropriate. Remember, it's also possible to claim a refund for over-withholding when you file your annual tax return if it turns out you were overtaxed.
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