Severance Pay and Taxes – (Q & A)

Oct 2017


Dear Rick:

I have an issue that I hope you can help me with.  I recently lost my job. I worked for the same company for over 25 years and the owner of the business died and his family has decided to close the business.  The business continued to pay my salary for six months as severance.  In addition, I also received a large bonus of $100,000.  When I received the bonus check taxes were already taken out.  I’ve been told that since I already received my severance that this money shouldn’t be taxed. My question is do I have to pay taxes on this money and if yes, how is it taxed?



Dear Julie:

Unfortunately, whoever told you the money was not subject to tax is wrong.  Whether you categorize the money as additional severance or a bonus is relatively immaterial to the IRS.  No matter what you call it the $100,000 you received as severance is taxed to you as ordinary income.


Because this money is ordinary income, it is taxed at your highest bracket.  What you may find is that the large bonus you received puts you into a higher tax bracket.  That means you may owe additional taxes than what was withheld from the check.  Depending upon your situation, you may find that you have to make an estimated tax payment to the IRS in order to avoid any penalty.  If you’re not familiar with how to do this, I recommend you sit down with someone professionally.


Of course, the question I have is what are you going to do with the extra money? The key is to focus on your individual situation.  If you’re going to need the money to cover living expenses, that’s one type of investment.  On the other hand, if you don’t need the money, you may be able to invest it long term.  In that regard, remember one of the best investments you can make is to pay down debt.  For example, if you carry a balance on your charge card you’re probably paying somewhere in the 20 percent range for that money.  Therefore, by paying down your charge card debt you’re getting a guaranteed after-tax return of 20 percent.  I can assure you no investment can match that.  Furthermore, another good use of this money may be to convert all or a portion of your traditional IRA into a Roth IRA.  The beauty of a Roth IRA is that money withdrawn from the plan is not subject to income taxes and the 701/2 mandatory distribution rules do not apply to Roth IRA’s


What I caution against is focusing on how you can spend the money as opposed to making it more productive.  Yes, you are entitled to reward yourself; however, let’s not forget we are adults and we have to make adult decisions.  That is why when you receive a bonus or an unexpected payment, you should look for ways to invest the money such as paying down debt, as opposed to looking for ways to spend it.


One last word of caution to everyone and that is to beware of tax advice from people who are not tax professionals.  These people mean well; however, generally speaking, they have no clue how our tax system works and taking advice from these people can be costly to you.  Therefore, only take tax advice from true professionals-it will save you money and aggravation.


Good luck!




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