Severance Pay: How It’s Calculated, What’s Included, Taxes Explained

When you’re laid off, the first thing most people focus on is the check — how much severance pay will you actually get, and how do you know if it’s correct? Your severance agreement is more than just a handshake or a lump sum; it’s a detailed contract that can hide missing amounts, miscalculated dates, and overlooked compensation.

This page dives into the financial side of severance agreements only: pay, bonuses, commissions, PTO, retirement accounts, equity, reimbursements, and taxes. These are the money topics that determine how much you walk away with — and whether you’re leaving value on the table.

When you’re laid off, it’s very likely your termination papers will include what’s called a severance package. At its core, severance pay is money your employer offers you when your job ends involuntarily — but how that money shows up (and what it covers) is where people often get tripped up.

It can take several different forms:

Lump sum payment: One check covering the entire amount.
Salary continuation: Paychecks that continue for weeks or months after your termination date.
Hybrid approach: A lump sum for part of it, and salary continuation for the rest.
None at all: Employers are not legally required to offer any severance pay. It is at their discretion, though, there are some general rules of thumb discussed below.

On the surface, it looks straightforward. But here’s the catch: the devil is in the details. A vague word like “salary” or a single typo in a date can mean you walk away with less than you deserve.

👉 Rule of thumb: Many employers use a baseline of one week of severance pay for every year of service. So if you worked for 10 years, you might expect 10 weeks of pay. But that’s just a guideline — senior employees and executives often negotiate much more.

And here’s what most people don’t realize: severance isn’t a gift, nor is it required. It’s an exchange.

Employers offer it in return for you signing a release of claims (basically a promise not to sue). That means you want to be extra careful about what you’re giving up versus what you’re getting.

Money Matters: Severance pay isn’t “free money.” It’s part of a contract. And that contract only protects you if you understand what’s inside it and what you're giving up for that money.

Why Dates Matter So Much

It sounds simple, but one wrong date can cost you money. In your severance papers,

double-check every single one:

Hire date: Impacts how your severance is calculated. If it’s wrong, you may be shortchanged on years of service.
Separation date: Determines your final paycheck, benefits cutoff, and unemployment eligibility.
Payment dates: Employers sometimes write vague lines like “eight weeks of pay.” If the dates don’t line up, your pay could stop earlier than expected.
Signature and effective dates: Control when obligations start and stop.

I’ve seen agreements where a typo in the termination date would have cut off payments weeks early. Convenient for the employer, costly for the employee. That’s why dates are the foundation of your severance.

👉 Action step: Read every date in your severance papers: hire, termination, signature, effective. If anything looks off, ask for it in writing.

Defining “Salary”

Most severance agreements use generic language like “salary continuation.” But what does “salary” actually include?

Base pay only? Or does it cover other compensation?
Commissions: If your monthly checks included commissions, you'll want ti now if your severance payment will account for that. Same with any earned commission right before termination, will it be paid if it’s not processed until 30–90 days later?
Bonuses: Annual or quarterly bonuses must be explicitly listed, or they may be excluded.
Other pay categories: Profit-sharing, stipends, shift differentials — anything with monetary value should be clarified.

The answer isn’t always clear. Odds are, it’s not defined — or defined loosely — in the agreement. And vagueness usually works in the employer’s favor.

Here’s a common scenario: you sell something the day before termination with a 10% commission attached. But commissions are usually processed 30–60 days later. If your agreement only says “salary continuation,” that commission may never make it to you.

👉 Action step: Go back at least one year (ideally your full employment history) and list every type of pay you’ve received: commissions, bonuses, allowances, stipends. If it isn’t explicitly written in your severance agreement, don’t assume it’s included.

Money Matters: If it’s not spelled out, it doesn’t count.

Bonuses, Commissions, and Incentives

Employers often avoid detail in severance paperwork because vague wording benefits them. But for you, vagueness means risk.

Bonuses: If you earned but haven’t yet been paid, make sure the agreement lists them.
Commissions: Confirm whether sales commissions due after your separation will still be honored.
Performance or signing bonuses: Check for clawback clauses that might require repayment.

If these aren’t clearly written in your agreement, the company doesn’t have to include them later.

Severance Pay and PTO

Unused time off is real money. But don’t assume it’s automatically included. Whether or not your employer is required to pay you for unused PTO varies state to state, but that doesn't mean you can't ask for it if it's not automatically included.

Vacation/PTO: Some states require payout by law; others leave it up to policy.
Sick leave: Usually not paid unless state law says otherwise.
Holidays: Floating or rolling holidays may carry value too.

Money Matters: I’ve seen agreements where PTO balances were missing or miscalculated. Those hours you banked? They’re cash in your pocket. Make sure they’re listed- especially if you've been banking years worth.

Lump Sum vs Salary Continuation

How your severance is paid can be just as important as how much you receive.

Lump Sum

How it works: One big payment.
Pros: Immediate access to cash, easier to plan, more control.
Cons: Taxed like a bonus (higher upfront withholding).

Salary Continuation

How it works: Biweekly or monthly checks, as if you’re still employed.
Pros: Maintains cash flow, sometimes extends benefits.
Cons: May stop if you get a new job, less flexible for big expenses.

Hybrid

Some employers combine both — e.g., PTO as a lump sum, base salary as continuation.

👉 Action step: Clarify in writing: Will you receive a lump sum, salary continuation, or both? When will payments be made?

Severance vs. Pension: Key Limits

Severance is not unlimited. The government sets two key limits to distinguish severance from a pension:

Severance cannot exceed double your previous year’s pay.
Severance cannot extend beyond two years from your separation date.

Example: If you earned $100,000 last year, your severance cannot exceed $200,000 or continue more than two years into the future. Anything beyond that may be taxed or treated as a pension plan- a type of retirement benefit.

Knowing these boundaries helps you understand what’s negotiable — and what isn’t.

Pension is a type of retirement benefit and may not be accessible without added taxes and fees if you are under retirement age.

Severance Pay and Taxes

All severance is taxable, and your employer is likely required to take withholdings; but how it’s taxes affects your take-home.

Lump sum: If you receive a lump sum severance payout, it will likely be taxed at the supplemental wage rate (like a bonus), which means higher upfront withholding.
Salary continuation: If you're severance pay is paid like on ongoing paycheck, it's likely to be taxed like regular wages, with normal paycheck withholding.
Installments: May affect unemployment eligibility depending on state law.

Employers are required to withhold taxes, but the structure changes your net/ take home amount. Sometimes you can negotiate timing (e.g., lump sum this year vs installments spread out) to fit your tax planning.

👉 Action step: Ask HR how severance will be taxed and whether it may affect unemployment eligibility in your state.

Retirement Accounts and 401(k) Matches

Pay like salary, commissions and bonuses are likely not the only monetary value you have from your employer. You may have retirement or stock funds that need to be accounted for too.

Your retirement funds are generally yours, but severance can affect:

401(k) matching contributions: Often stop immediately upon termination.
Vesting schedules: If you’re mid-vesting, unvested portions may be forfeited unless the company agrees to accelerate them. Confirm if any unvested stock or matches become your upon termination or if they revert back to the company.

Severance agreements should address whether matches or vesting continue — or stop entirely.

A client of mine was two years into a four-year stock vesting plan when he was let go. Without clarity, he lost the remaining unvested stock- half the value of his bonus form two years ago. Always ask: will stock continue vesting, roll up immediately, or be forfeited and get it explicitly added to your agreement.

Tuition and Relocation Reimbursements

Did your company pay for part of your education or relocation? If so, read carefully.

Tuition reimbursement: Often requires a minimum service period. If you’re laid off before that period ends, you need written confirmation that repayment isn’t required. (When I was in law school, I had to repay my employer when I left before my five-year commitment.)
Relocation benefits: Similarly, repayment clauses may be triggered unless the severance agreement addresses them.

Money Matters: These are easy for HR to overlook during lay offs because they were on other agreements. But if they aren’t explicitly addressed, the old contracts still apply — and you could be on the hook.

Expense Reimbursements

Final expense reports (travel, equipment, memberships) should be filed quickly. If not, you could lose out. Your severance agreement should confirm whether outstanding reimbursements will be paid.

Final Thoughts

The money in your severance agreement isn’t just about one number. It’s about dozens of details that add up to thousands of dollars. Dates, definitions, tax treatment, PTO, bonuses, commissions, equity — every line matters.

The bottom line: never assume. If it isn’t written clearly, it isn’t guaranteed. Ask questions, get clarification, and don’t be afraid to negotiate.

Even if your severance is “standard,” taking the time to review the money sections could make the difference between walking away shortchanged and walking away with everything you’ve earned.