Is severance pay taxable income?

The core rule

Publication 525 handles severance in two short sentences, and both are worth taking literally. First, you must include in income the amounts you receive as severance pay and any payment for the cancellation of your employment contract. That wording covers the usual layoff package, but it also reaches money paid to end a contract early or to buy out the remaining term. Second, the publication explains the payroll-tax side: severance payments are subject to social security and Medicare taxes, income tax withholding and FUTA tax. In other words, an employer treats severance like ordinary wages, not like a one-off gift or a return of capital.

Why it behaves like wages

The publication points to section 15 of Publication 15, which discusses special rules for various types of services and payments, to explain that severance payments are wages for social security and Medicare purposes. Because they are wages, the amount belongs in the Form 1040 or 1040-SR line 1a total. The publication’s general instruction applies here too: include all of your pay on line 1a, even if you do not receive a Form W-2 or the one you receive does not include everything it should.

One practical consequence is timing. Income is generally counted for the year in which it is received, so a package paid out across two calendar years is split between those years rather than treated entirely in the year of the layoff. The publication does not set out a special spread-back rule for severance, so do not assume one exists.

The outplacement trade-off

The only twist the publication adds is outplacement. Some employers offer to reduce a severance check in exchange for services such as training in résumé writing and interview techniques. The publication says that if you choose to accept a reduced amount of severance pay in order to receive those services, you must include the unreduced amount of the severance pay in income. The value of the services therefore does not become tax free just because it never passed through your bank account. You are taxed as if you had received the full severance and then spent part of it on the coaching.

This catches people who think they are saving tax by swapping cash for a program. They are not; the swap changes how the money is used, not how much is taxed.

Worked example

An employer offers $20,000 of severance. An employee agrees to take $17,500 in cash and have the employer provide outplacement services worth $2,500 instead. The employee must include the unreduced $20,000 in income, which is the $17,500 actually received plus the $2,500 value of the services. Any income tax withholding applies on the wage side, and the social security and Medicare taxes apply to severance as wages. The calculator above adds the two numbers for you; enter the cash paid and the value of the services chosen in place of the rest.

Related payments and limits

Severance is not the same as every payment a departing employee receives. Publication 525 deals separately with accrued leave: a federal employee who receives a lump-sum payment for accrued annual leave at retirement or resignation has the amount included as wages on Form W-2. It also covers back pay awards, discussed on its own page here. Unemployment benefits are a different category with their own Form 1099-G reporting. This page does not cover state rules, the exact withholding rate on supplemental wages, or tax on any retirement-plan rollover of part of a package. For a rough view of how an extra lump sum is taxed on top of regular pay, try the bonus tax calculator, and check federal tax brackets to see where the added income lands.

Sources

• IRS Publication 525, Taxable and Nontaxable Income (2025): the Severance pay, Accrued leave payment and Outplacement services entries under Miscellaneous Compensation. Read November 2, 2026.

Edition read: Publication 525 (2025), for use in preparing 2025 returns. Dollar limits and dates in this publication are for 2025; check the current publication and form instructions for your tax year. This page summarizes the publication and does not replace it.