Lost Your Job? Here are the Tax Aspects of an Employee Termination

Despite the robust job market, some people are still losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, you may face tax implications due to your changed personal and professional circumstances. Depending on your situation, these can be complex and require you to make decisions that may affect your tax picture — both this year and in the future.

Unemployment and severance pay

 Unemployment compensation is taxable for federal tax purposes, as are payments for any accumulated vacation or sick time. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

• If you sell stock acquired by way of an incentive stock option, part or all of your gain may be taxed at lower long-term capital gains rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
  
  
• If you received — or will receive — what’s commonly referred to as a golden parachute payment, you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under complex rules. In addition, the excess parachute payment also is subject to ordinary income tax.
  
  
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

 Health insurance

If your ex-employer pays for some of your medical coverage for a period of time following termination, you won't be taxed on the value of this benefit.

Retirement plans

Employees whose employment is terminated may also need tax planning help to determine the best option for distributions of amounts accumulated in retirement plans sponsored by their former employers. For most employees, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout. The rollover should be made directly from the plan to the IRA to defer taxes.

If the distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction.

Further, any loans you’ve taken out from your employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately, or within a specified period. If such a loan isn’t repaid, it may be treated as if the loan is in default and will be treated as a taxable deemed distribution.

If you’re under the age of 59½ and make withdrawals from your company plan or IRA to supplement your income, there may be an additional 10% penalty tax in addition to the income tax, unless you qualify for an exception.

Contact us so that we can chart the best tax course for you during this transition period.

The HoganTaylor Tax Practice

If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax practice, please email Tony Otto, Tax Practice Lead, at jotto@hogantaylor.com.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.