 Dear Tax Talk,
Is an employer required to withhold federal,
state and local taxes, and/or FICA from severance pay, or is
the terminated employee entitled to a lump sum with payment
of taxes himself? Can you point to the IRS ruling or regulation
for this? Thank you.
-- PM
 Dear
PM,
Sorry to see you go, but your employer has to hold back a
little for Uncle Sam.
An employer is obligated to treat severance
payments as wages and must withhold taxes. In addition to
FICA and Medicare tax at a combined rate of 7.65 percent,
the employer must withhold income tax. An employer can withhold
at a flat 25 percent rate or can use the withholding tables
provided in the Internal Revenue Service's publication Employer's
Tax Guide, Circular E. State and local taxes would similarly
be due. Page 13 of Circular E provides guidance to employers
on withholding for supplemental wage payments such as severance,
bonuses and commissions.
An employee is always treated as an employee
for all remuneration. For example, an employer that pays commissions
in addition to salary would be required to withhold on the
commissions. The employer cannot treat the commissions as
independent contractor payments. Similarly an employee awarded
back pay that arises out of an employment dispute would also
be subject to tax withholdings even though the pay may come
years after the employment relationship terminated.
-- Posted: Jan. 28, 2005
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