HR Hotline: Is Severance Pay Taxable Wages?

Q: We are paying a departing employee severance, and she is insisting that we shouldn’t take out regular payroll taxes. Is severance pay taxable wages?

A: For some time that question was up for grabs, as different courts issued contradictory opinions. That left employers and terminated employees uncertain about their tax obligations where severance packages were offered.
Finally, however, in a unanimous 8-0 decision handed down in March, the U.S. Supreme Court resolved the conflict among the courts.
The ruling held that severance payments are taxable wages subject to FICA (Social Security and Medicare) taxes in cases where such payments are made to employees who are involuntarily terminated, the amount of severance varies based on seniority, and eligibility is not linked to the receipt of state unemployment benefits.