Is Severance Pay Taxed in California?

Yes. Severance pay is taxed. Both the IRS and California's Franchise Tax Board treat severance as ordinary income. That means federal income tax, state income tax, Social Security, and Medicare all apply. This isn't negotiable with your employer. It's the law.

But how much you actually owe depends on the structure of your severance, your other income for the year, and some choices you may be able to make during negotiation.

How Severance Is Taxed

Federal income tax. The IRS classifies severance as supplemental wages. For supplemental wages under $1 million, your employer will typically withhold a flat 22% for federal tax. For amounts over $1 million, the rate jumps to 37% on the excess. This is just withholding. Your actual tax liability depends on your total income for the year and your tax bracket.

California state income tax. California also taxes severance as ordinary income. The state supplemental wage withholding rate is 6.6%. Again, your actual liability depends on your total income. California has a progressive tax structure with rates up to 13.3% for the highest earners, which hits many Los Angeles professionals hard.

Social Security and Medicare. Severance is subject to FICA taxes: 6.2% for Social Security (up to the annual wage base) and 1.45% for Medicare. If your combined wages and severance exceed $200,000 for the year, you may also owe the Additional Medicare Tax of 0.9%.

California SDI. State Disability Insurance at 1.1% also applies to severance pay.

Lump Sum vs. Salary Continuation

The structure of your severance payment affects both withholding and your overall tax picture. This is something you can sometimes negotiate.

Lump sum. You receive the entire severance amount in one payment. Withholding will be at the supplemental wage rates mentioned above. The advantage: clean break, money in hand. The disadvantage: a large lump sum on top of your regular earnings for the year could push you into a higher tax bracket.

Salary continuation. Your employer continues paying your regular salary for a set period after termination. Withholding is calculated the same way as your regular paychecks. The advantage: potentially smoother tax treatment since the income is spread over time. The disadvantage: it may affect your unemployment benefits, since the EDD may view you as still "employed" during the continuation period.

There's no universally better option. It depends on your total income for the year, whether you plan to file for unemployment immediately, and your cash flow needs.

What About the Non-Cash Parts?

If your severance package includes non-cash benefits, the tax treatment varies:

Health insurance continuation. If your employer pays COBRA premiums on your behalf as part of the severance, those payments are generally not taxable to you. This is one reason health insurance continuation is a valuable part of any severance negotiation.

Outplacement services. The value of employer-provided outplacement assistance is generally not taxable.

Equity acceleration. If your severance agreement includes accelerated vesting of stock options or RSUs, those will be taxed based on their value at the time of vesting. This can create a significant tax event, especially if the stock has appreciated.

Tax Planning Considerations

Timing matters. If you're terminated late in the year and have already earned most of your annual salary, a lump sum severance payment will be taxed on top of that income. If possible, negotiating for the payment to be made in January of the following year could result in a lower effective tax rate because you'd have less other income that year.

Retirement account contributions. You may be able to reduce your tax liability by contributing a portion of your severance to a traditional IRA (if eligible) or by rolling over any employer retirement plan balance.

Consult a tax professional. Employment attorneys can negotiate your severance terms, but for specific tax planning advice, you should work with a CPA or tax advisor who can model the tax impact of different payment structures based on your complete financial picture.

Common Mistakes

Confusing withholding with actual tax. The 22% federal withholding rate is not your tax rate. It's an estimate. You'll reconcile the actual amount owed when you file your return. Depending on your total income, you might owe more or get a refund.

Forgetting about estimated taxes. If you receive a large severance and won't have employer withholding for the rest of the year, you may need to make quarterly estimated tax payments to avoid penalties.

Ignoring state taxes. California's top rate of 13.3% is the highest in the country. Between federal and state income tax, Social Security, and Medicare, the total tax on severance can approach 40% or more for higher earners in LA.

Get the Structure Right

Tax treatment is one more reason to have your severance agreement reviewed before you sign. The difference between a lump sum in December and salary continuation into the new year could save you thousands. If you're in Los Angeles or anywhere in Southern California, our employment team can review your agreement and help you understand the full financial picture, not just the gross number.