This is for small employers who are letting someone go and want to offer severance, or have agreed to. It covers what federal law requires, how to tax the payment, how it shows on the final pay stub and W-2, and the release rules for employees aged 40 and over. If you are the employee, the tax section explains what you will see deducted.
Is severance pay required?
Not by federal law. The Department of Labor says the Fair Labor Standards Act has no requirement for severance pay, and that severance is a matter of agreement between an employer and an employee. It is often based on length of service.
You may still owe it if you promised it: in an employment contract, an offer letter, a handbook policy or a severance plan. The Department of Labor's Employee Benefits Security Administration can help employees who didn't receive severance benefits under an employer-sponsored plan. State law can also add rules, so check yours.
Severance is separate from final pay. The employee's last regular wages, and accrued vacation where your state requires it to be paid out, are due on your state's final-paycheck schedule whether or not you pay severance.
How is severance pay taxed?
As wages. IRS Publication 15 says severance payments are wages subject to Social Security and Medicare taxes, federal income tax withholding and FUTA, and it lists severance among supplemental wages, alongside bonuses and back pay.
| How you pay it | Federal income tax withholding |
|---|---|
| With a regular paycheck, amounts not shown separately | Withhold on the total as one regular payment |
| Separately, or shown as its own amount | Flat 22% (if you withheld from the employee's regular wages this year or last), or the aggregate method |
| Supplemental wages above $1 million in the year | 37% on the excess, whatever the W-4 says |
| Every method | Social Security 6.2%, Medicare 1.45% and FUTA also apply |
A worked example
Say you pay a departing employee $10,000 of severance in a separate check, and you withheld income tax from their regular wages this year.
| Line | Amount |
|---|---|
| Severance pay | $10,000.00 |
| Federal income tax (22%) | −$2,200.00 |
| Social Security (6.2%) | −$620.00 |
| Medicare (1.45%) | −$145.00 |
| Net before state tax | $7,035.00 |
| Your employer Social Security and Medicare | $765.00 |
Social Security stops once the employee's 2026 wages pass $184,500, so check year-to-date wages before you apply the 6.2%. Federal unemployment tax only applies to the first $7,000 of each employee's wages in the year, which a long-serving employee has usually already passed. State income tax applies on top.
Supplemental wage tax calculator: 22% or aggregate YTD calculator
Timing: when to pay it
Federal law sets no deadline for severance, so the timing is whatever your agreement says: a lump sum on the last day, after a release is signed, or as salary continuation over several pay periods. Salary continuation runs through your normal payroll, so each installment goes on its own pay stub.
If you ask the employee to sign a release of claims in return for severance, and they are 40 or older, the federal Older Workers Benefit Protection Act sets minimum terms for waiving age discrimination claims. The EEOC lists them:
- The waiver is in writing, refers specifically to rights or claims under the Age Discrimination in Employment Act, and advises the employee in writing to consult an attorney.
- The employee gets at least 21 days to consider it, or at least 45 days when the offer is part of a group termination program.
- The employee has 7 days after signing to revoke it, so pay after that period ends.
How severance shows on the pay stub and W-2
Put severance on its own earnings line, labelled "Severance", not mixed into regular pay. If it is in the final paycheck, show the last regular wages, any vacation payout and the severance as separate lines, each with its tax treatment, and the year-to-date totals that will feed the W-2. At year end, severance is part of wages in boxes 1, 3 and 5 of Form W-2.
Keep the signed agreement with the payroll record for that pay date. It is what explains the payment if the employee, the IRS or your state asks.
Where PayDocs fits
PayDocs makes the final pay stub from your payroll figures, with severance on its own earnings line next to the last regular wages and any vacation payout, plus year-to-date totals that match the W-2. PayDocs works out federal income tax, Social Security, Medicare and supported state taxes for 2026 pay dates (see what we calculate). Every line stays editable. PayDocs doesn't pay the employee or file anything. Previewing is free; a PDF is $4.99 per pay stub once checkout opens.
This is general information about US federal rules as of 8 October 2026, not tax or legal advice. State rules add to it; check your state's labor and revenue departments.
Questions
Is severance pay required?
Not under federal law. The Department of Labor says severance is a matter of agreement between employer and employee. You owe it if a contract, policy or plan promises it, and state law can add rules.
How is severance pay taxed?
As supplemental wages. Withhold federal income tax at a flat 22% or by the aggregate method, plus 6.2% Social Security and 1.45% Medicare, and pay your employer share and FUTA. It goes on the W-2.
Is severance pay subject to Social Security and Medicare?
Yes. IRS Publication 15 says severance payments are wages subject to Social Security and Medicare taxes, until the employee's 2026 wages pass the $184,500 Social Security wage base.
When do you have to pay severance?
Federal law sets no deadline; your agreement decides. If you ask an employee aged 40 or over to sign a release, they get at least 21 days to consider it and 7 days to revoke after signing.
Does severance go on the final pay stub?
Yes, if it is paid in the final paycheck: show it on its own earnings line, separate from the last regular wages and any vacation payout, with the tax withheld and year-to-date totals.
Sources
- US Department of Labor: Severance pay
- IRS: Publication 15 (2026), Employer's Tax Guide
- EEOC: Understanding waivers of discrimination claims in employee severance agreements
Sources checked October 8, 2026. This article explains how pay documents work; it is not tax or legal advice.
