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Determine how the severance will be paid. Typically, employers pay employees severance based on their length of service. The employer can pay the severance as a lump-sum payment or make payments to the employee each pay period.
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Withhold the excess of $1 million at 35 percent if the severance pay coupled with other supplemental wages exceeds $1 million in a calendar year. Regardless of the employee’s W-4 data, the excess should be withheld at 35 percent.
If severance is paid with the employee’s normal pay, withhold taxes as if it is a sole payment, without specifying the amounts paid. The tax amount will depend on the employee’s W-4 (filing status and number of allowances) and the Internal Revenue Service Withholding
Tables (Circular E) for the year you are computing.
If severance is paid separately and the employee had income tax withholdings in the present or prior calendar year, you can withhold the severance tax at a flat 25 percent. If no income tax was withheld from the employee’s normal pay in the present or prior calendar year, you can combine the severance with the employee’s regular pay and withhold the taxes as a single payment.
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Deduct state taxes, if applicable. Since a select few states such as Florida and South Dakota do not charge state income tax, deducting state tax from severance pay varies by state. Check with your state department of labor office to know if you should withhold state taxes and at what rate.