Leaving a Job? Don’t Take a Tax Surprise with You

Leaving a Job? Don’t Take a Tax Surprise with You

A recent Supreme Court decision could impact the taxes you pay when you leave a job. Being aware of this new change could save you plenty if you pay attention to your severance…

An inevitable part of life is a changing jobs. Now a recent Supreme Court decision clarifies that severance payments you receive when you leave your job are wages and subject to employment taxes. So how might this impact you?

Background

All employees and employers pay FICA taxes. There are two components;

Social Security. Social Security tax rates are 6.2% for the employee and 6.2% for the employer (total 12.4%) on the first $117,000 of wages in 2014.

Medicare. Medicare tax is 1.45% for the employee and another 1.45% for the employer (total 2.9%). There is also a potential Obamacare surcharge if your wages exceed $200,000 single and $250,000 married.

Many employers who pay a severance check to employees when they leave have classified these checks as other, non-wage, income. This allows both the employer and employee to save on paying these FICA taxes.

What you should know

In a recent Supreme Court ruling, these severance checks are now deemed to be wages and subject to employment taxes. The IRS estimates there are currently over $1 billion in potential wages that are impacted by this decision. Knowing this, here are some tips to consider.

  • Check withholdings. If you leave your job ensure all payments to you are wages on a W-2. Check your last payroll check to see that the correct Social Security and Medicare taxes have been withheld.
  • The 1099 warning flag. If you receive a check without a payroll stub, you will probably be receiving a 1099 in the future. In this case, you could be picking up the employer’s Social Security and Medicare tax responsibility as well as your own. To avoid this unpleasant surprise, ask for clarification from your former employer. Get the payment reissued as wages, if appropriate.
  • Other things to check. While you are at it, review that final employer payment to ensure your unused vacation is also paid to you per their employee policy. When you check for withholdings on your last paycheck also ensure the level of withholding is at the level you requested on your normal paycheck. Often these last checks use withholding defaults versus the level you requested on your W-4.
  • Other benefits. While this tax tip deals with severance check taxability, don’t forget to plan for the transition of your other benefits as well. These include things like health insurance, dental/vision, retirement plans, Health Savings Accounts, and pensions.