Laid Off This Year? What It Means for Your Taxes

A layoff changes more than your paycheck. Severance, unemployment benefits, your 401(k), stock options and health insurance each come with their own tax rules, and a few of them have deadlines that arrive quickly. With layoffs continuing across Bay Area tech, here is what to know before you file.

1. Severance and Final Pay Are Taxable Wages

Severance pay is taxed like any other wages. So is a payout of unused vacation or PTO. Both appear on your W-2 and are subject to income tax, Social Security and Medicare.

Tip:
A lump-sum severance is usually withheld at a flat 22% for federal tax. Depending on your total income for the year, that may be too much or too little. Do not assume it settled the bill.

2. Unemployment Benefits: Taxable Federally, Not in California

Unemployment compensation is taxable on your federal return. You will receive Form 1099-G showing the amount.

• No tax is withheld unless you ask for it. You can request withholding with Form W-4V.
• If you do not, you may need to make estimated payments or set money aside for April.

Bay Area Consideration:
California does not tax unemployment benefits. They are subtracted on your state return, so make sure your preparer makes that adjustment.

3. Your 401(k): Roll It Over the Right Way

You can usually leave your 401(k) where it is, move it to a new employer’s plan, or roll it into an IRA. If you move it, how you do it matters.

• Direct rollover: the plan sends the money straight to the new plan or IRA. Nothing is withheld and nothing is taxed.
• Check made out to you: the plan must withhold 20% for federal tax. You then have 60 days to deposit the full amount into an IRA, including the 20% you did not receive, which has to come out of your own pocket. Whatever you do not roll over is taxed.

If you need the money:

• Withdrawals before age 59½ are generally hit with a 10% additional tax on top of regular income tax.
• The age 55 rule: if you leave your job in or after the year you turn 55, withdrawals from that employer’s plan are exempt from the 10%. This does not apply to IRAs, so rolling the money to an IRA first gives up the exception.
• Health insurance premiums: if you received unemployment compensation for 12 weeks, IRA withdrawals used to pay health insurance premiums are exempt from the 10%. This one applies to IRAs, not 401(k)s.

4. Stock Options and RSUs

• Incentive stock options generally must be exercised within three months of your last day to keep their ISO tax treatment. Check your grant agreement for the actual deadline to exercise at all.
• Unvested RSUs are usually forfeited. If your company accelerates vesting as part of severance, the value is wages in the year the shares vest.

See RSUs, ESPP and Stock Options: How to Avoid Paying Tax Twice.

5. Health Insurance: COBRA or Covered California

COBRA lets you keep your employer’s plan at full cost. Premiums are paid with after-tax money. They count as a medical expense if you itemize, but only medical costs above 7.5% of your AGI are deductible.

Covered California may cost less, depending on your income for the year. Two rules changed for 2026:

• The premium tax credit is again limited to households with income at or below 400% of the federal poverty line.
• There is no longer a cap on repaying excess advance credits. If you estimate your income too low and receive too much subsidy, you repay all of it at tax time.

Tip:
Report income changes to Covered California as they happen, including severance and a new job. That keeps your subsidy accurate and avoids a surprise in April.

If you have an HSA: you can use it tax-free to pay COBRA premiums, or health insurance premiums while you are receiving unemployment benefits.

6. Job Search Costs

Job search expenses are not deductible on your federal return. California still allows certain miscellaneous itemized deductions above 2% of AGI, so if you itemize on your state return, keep your receipts and ask.

7. A Low-Income Year Can Be an Opportunity

If your income is well below normal this year, some moves cost less in tax than they ever will again:

• Converting part of a traditional IRA to a Roth at a lower bracket.
• Selling appreciated investments while you are in a lower capital gains bracket.

Both add to your income, which can reduce a health insurance subsidy, so run the numbers first.

Final Thoughts

The months after a layoff are when small decisions, such as how a rollover check is written or when options are exercised, have the largest tax consequences. If you have been laid off or expect to be, call us before you sign the separation paperwork or move your retirement money.

Sources: IRS Tax Topic 418, Unemployment Compensation; IRS “Rollovers of retirement plan and IRA distributions” and “Exceptions to tax on early distributions” pages; IRS Premium Tax Credit questions and answers; California FTB “Unemployment” page and 2025 Schedule CA (540) instructions.