Taxes When You Are Laid Off in the U.S.: Severance, PTO Payouts, 401(k) Rollovers and Loan Offsets, and Unemployment Benefits

Being laid off in the U.S. can trigger several tax events in one year: severance pay, a payout of unused vacation, a final paycheck, decisions about your 401(k), and unemployment benefits. When you are focused on next steps, it is easy to overlook how each item is taxed, and that can lead to a surprise balance due or double taxation the following spring.

Based on IRS Publications 525, 15 (Circular E), and 575 and related IRS guidance, this article lays out the tax points to know in a layoff year. It is written for locally hired Japanese employees, green card holders, and former expatriates who switched to local employment.

If you work in the U.S. on a work visa, your immigration status after a layoff is a separate question from your taxes. This article covers general tax information only and does not give immigration advice; please consult an immigration attorney about your status.

Key points

• Severance pay is taxable wages, subject to Social Security and Medicare tax, and reported on your W-2.
• Severance and lump-sum vacation payouts are supplemental wages and may be withheld at a flat 22% (37% on supplemental wages over $1 million in a year). Withholding is not your final tax.
• A direct rollover of your 401(k) has no withholding. If the money is paid to you, 20% is withheld, and to roll over the full amount within 60 days you must make up the 20% from other funds.
• If an outstanding 401(k) loan is offset because you left your job (a qualified plan loan offset), you can roll over that amount until your tax return due date, including extensions.
• Unemployment benefits are taxable for federal income tax and reported on Form 1099-G. You can elect 10% withholding with Form W-4V.

Severance pay is taxed as wages

Publication 525 says you must include severance pay and any payment for the cancellation of your employment contract in income. Severance payments are wages subject to Social Security and Medicare taxes, and are also subject to income tax withholding and FUTA tax. For tax purposes, severance is treated much like regular pay or a bonus.

• Reported on your W-2: Severance is included in your W-2 wages. W-2s follow the payment date, so if you leave in 2026 but your severance is paid in 2027, it goes on your 2027 W-2.
• Severance reduced for outplacement services: Publication 525 says you must include the unreduced amount of severance in income.
• Supplemental unemployment benefits from an employer-financed fund: These are not unemployment compensation. They are taxable as wages and subject to income tax withholding, and may be subject to Social Security and Medicare tax.

How withholding works on supplemental wages

Publication 15 lists bonuses, commissions, overtime, payments for accumulated sick leave, severance pay, and back pay, among others, as supplemental wages. When they are paid separately from regular wages, the employer withholds federal income tax in one of these ways:

Method	How it works	When it applies
Flat rate	Withhold a flat 22% of the supplemental wages	Allowed if income tax was withheld from regular wages in the current or prior year
Aggregate	Add the payment to regular wages, figure withholding on the total, and subtract what was withheld from the regular wages	Required if no income tax was withheld from regular wages
Over $1 million	Mandatory 37% (the highest rate) on supplemental wages above $1 million for the year	Applies regardless of Form W-4

For vacation pay, Publication 15 says it is subject to withholding like regular wages, but when it is paid in addition to regular wages for the vacation period, such as an annual lump-sum payment for unused vacation, it is treated as supplemental wages. A payout of unused vacation at termination usually fits that description. Whatever method is used, supplemental wages are subject to Social Security and Medicare taxes.

Example: 22% withholding vs. your actual tax

Example (hypothetical): An employee earning $150,000 a year is laid off in 2026 and receives $40,000 of severance and an $8,000 vacation payout, paid separately from regular wages. Under the flat-rate method, federal income tax withholding is $48,000 × 22% = $10,560.

But 22% is only a withholding rate. Your tax for the year is figured on your return using all of your income: regular wages, severance, unemployment benefits, retirement plan withdrawals, and so on. If some of that income falls in brackets above 22%, you will owe more; if your effective rate is lower, you may get a refund. A large severance or a gap in income can push your actual tax far from what was withheld, so run the numbers early.

What to do with your 401(k): rollover basics

After you leave, you need to decide what to do with your 401(k) balance. Based on IRS guidance, the main options and their tax treatment are below. Depending on the plan’s terms, you may also be able to leave the money in the plan.

Option	Tax	Withholding	Watch out for
Direct rollover to an IRA or a new employer’s plan	Not taxed until you withdraw	None	A new plan does not have to accept rollovers; check first
Paid to you, rolled over within 60 days	Amount rolled over in 60 days is not taxed	20% mandatory	To roll over the full amount, replace the 20% withheld from other funds
Cash out (no rollover)	Taxable (except qualified Roth distributions and amounts already taxed)	20% mandatory	Generally a 10% additional tax if under age 59½, unless an exception applies

One exception to the 10% additional tax, per Publication 575, covers distributions from a qualified plan after you separate from service in or after the year you reach age 55. If you leave before the year you turn 55, this exception does not apply. Note that the IRS lists it as an exception for distributions from qualified plans such as a 401(k).

IRA-to-IRA rollovers are limited to one in any 12-month period, but that limit does not apply to rollovers from a plan such as a 401(k) to an IRA, or to trustee-to-trustee transfers.

Example: missing the 20% on a 60-day rollover

Example (hypothetical): You are 45, leave your job, and take a $50,000 check from your 401(k), all from pre-tax contributions and earnings. The plan withholds 20%, or $10,000, so you receive $40,000.

• You roll over only the $40,000 within 60 days: The $10,000 not rolled over is taxable, and unless an exception applies, there is also a $1,000 additional tax (10%). The $10,000 withheld is credited as tax paid on your return.
• You add $10,000 of your own money and roll over $50,000: None of the distribution is taxable and there is no 10% additional tax. The $10,000 withheld is settled on your return.

Choosing a direct rollover from the start avoids this cash crunch. If you miss the 60-day deadline, the IRS offers three ways to get relief: an automatic waiver, self-certification for qualifying reasons, or a private letter ruling.

If you have a 401(k) loan: plan loan offsets

If you borrowed from your 401(k), the unpaid loan balance may be subtracted from your account when you leave. This is a plan loan offset, and the offset amount is treated as a distribution.

• Qualified plan loan offset: A loan in good standing that is offset because the plan terminates or because you have a severance from employment. For tax years after 2017, you have until the due date of your return for the year of the offset, including extensions, to roll it over. Form 1099-R shows code M in box 7.
• Other offsets: You have 60 days from the offset to complete a rollover.
• Deemed distributions: A loan treated as a distribution, for example after a default, is shown with code L on Form 1099-R and cannot be rolled over.

Example (hypothetical): A $12,000 401(k) loan balance becomes a qualified plan loan offset when you are laid off in 2026. You never receive the $12,000 in cash, but if you deposit $12,000 of your own money into an IRA by the due date of your 2026 return (including any extension), it is treated as a rollover and not taxed. If you don’t, the $12,000 is taxable, and if you are under 59½ and no exception applies, the 10% additional tax applies too.

Unemployment benefits

Publication 525 says you generally must include all unemployment compensation in income. Your state sends Form 1099-G with the total in box 1. If it does not arrive by mail, the IRS notes you may need to get it from your state’s website.

• Withholding: Give Form W-4V to the paying office to have 10% federal income tax withheld.
• If you skip withholding: You may need to pay estimated tax, and underpaying can lead to a penalty.
• Repayments: If you repay benefits in the same year you received them, subtract the repayment from the total you report.

States have their own rules for taxing unemployment benefits, so check your state as well.

Common oversights in a layoff year

1. More than one W-2: You will get W-2s from your old and new employers. If a former employee asks for a W-2, the employer should provide it within 30 days of the request or of the final wage payment, whichever is later.
2. Excess Social Security tax: If you worked for more than one employer during the year and more than $11,439 of Social Security tax was withheld in total for 2026, you may be able to claim the excess on your return.
3. Forms 1099-R and 1099-G: 401(k) distributions and loan offsets are reported on Form 1099-R, and unemployment on Form 1099-G. Rollovers still need to be reported on your return.
4. Underwithholding: If you did not elect withholding on unemployment benefits, or your new job withholds too little, consider estimated payments or a new Form W-4.
5. Equity awards: For ESPP tax treatment, you generally must be an employee from the grant date until 3 months before the purchase. Leaving can change how your RSUs or ESPP are handled, so read your company’s plan materials.

If you are on a visa or moving back to Japan

If a layoff leads you to move back to Japan, keep these tax points in mind. Questions about visa status or departure deadlines are immigration matters for an immigration attorney.

• Your departure year: If you change from U.S. resident to nonresident during the year, you may need to file a dual-status return covering both periods.
• Severance received after you leave: Severance is pay for services. Publication 519 sources multiyear compensation by the share of workdays in the United States, so severance paid after you move may still be U.S.-source income that must be reported in the U.S.
• Leaving your 401(k) in the U.S.: Withdrawals after you return involve withholding and U.S.–Japan tax treaty questions; see the related articles.
• State tax: If you are leaving a state such as New York or California, watch the state’s residency rules.

FAQ

Only 22% was withheld from my severance. Is that enough?

22% is a withholding rate, not your final tax rate. If your tax for the year, figured on all your income, is more than what was withheld, you will owe the difference when you file. With a large severance, consider making an estimated tax payment.

How is a payout of unused vacation taxed?

It is taxed as wages and is subject to Social Security and Medicare tax. Publication 15 says that a payment in addition to regular wages, such as a lump-sum payout of unused vacation, is withheld on as supplemental wages.

Does rolling my 401(k) into an IRA count toward the once-a-year rule?

No. The IRS says the one-per-12-months limit applies to IRA-to-IRA rollovers. Plan-to-IRA rollovers and trustee-to-trustee transfers are not limited.

I missed the 60-day deadline. What now?

The IRS describes three routes: an automatic waiver, self-certification under Revenue Procedure 2020-46 and related guidance for qualifying reasons, or a private letter ruling. Whether self-certification works depends on why you missed the deadline, so act quickly.

Do I have to report unemployment benefits?

Yes. Unemployment benefits are subject to federal income tax. Report the amount from the Form 1099-G your state sends you.

At CLT NY INC., an IRS Enrolled Agent can prepare your return for a layoff year, report 401(k) distributions and rollovers correctly, and handle dual-status returns for the year you move back to Japan, in Japanese or English. Contact us.

Related articles

• 401k Decisions Upon Repatriation to Japan: Liquidate or Leave? A Comprehensive Guide to US-Japan Tax Treaty & State Tax Risks
• Withdrawing a 401(k) or IRA After Returning to Japan: 30% Withholding and Relief Under the US-Japan Tax Treaty
• Expat’s Essential Guide: Navigating Dual-Status Tax Filing for US Arrival & Departure Years
• Mastering Form W-4: A Comprehensive Guide for Japanese Nationals on Adjusting U.S. Tax Withholding
• The Freelancer’s Complete Guide to Estimated Tax: Calculation Methods and Penalty Avoidance Strategies
• Navigating the Strict State Taxes of New York and California: Residency Risks for Individuals Returning to Japan

Sources: IRS, Publication 525 (2025), Taxable and Nontaxable Income; IRS, Publication 15 (2026), (Circular E), Employer’s Tax Guide; IRS, Rollovers of retirement plan and IRA distributions; IRS, Topic no. 413, Rollovers from retirement plans; IRS, Publication 575 (2025), Pension and Annuity Income; IRS, Publication 519 (2025), U.S. Tax Guide for Aliens; IRS, General Instructions for Forms W-2 and W-3 (2026). Information as of October 2026. This article provides general information and is not individual tax advice.