Korean Severance Pay (Toejikgeum / 퇴직금) and US Expat Taxes

How Statutory Severance (Toejikgeum) Works in South Korea

Under South Korea's Labor Standards Act and the Employee Retirement Benefit Security Act, employees who complete at least one continuous year of service with at least 15 working hours per week are legally entitled to statutory severance pay (toejikgeum / 퇴직금).

The statutory minimum severance formula requires employers to pay at least 30 days of average wages for each continuous year of employment. For long-tenured employees at Korean corporations, chaebols, foreign subsidiaries, or hagwons, this lump sum often amounts to tens of thousands of dollars.

The Cross-Border Tax Mismatch: Korea vs. IRS

The core compliance dilemma stems from fundamentally differing tax characterizations:

• South Korea (Favorable Retirement Income): Korea taxes severance under a separate category known as retirement income (퇴직소득 / Toejik Sodeuk). Instead of stacking this payout onto your annual global income brackets (which reach up to 45% + 10% local surtax), the National Tax Service (NTS) applies generous tenure deductions and bracket-smoothing formulas. The resulting effective Korean tax rate is typically between 2% and 6%.
• United States (Ordinary Compensation): The IRS does not recognize Korean retirement income formulas. Under IRC §61, statutory severance is considered deferred compensation for services rendered, taxable as ordinary income at standard federal rates (up to 37%) in the calendar year received.

Navigating Relief: Foreign Tax Credit (FTC) vs. FEIE

When filing your US federal return for the year of departure, mitigating the severance tax hit requires strategic elections on Form 1116 or Form 2555:

1. Foreign Tax Credit (Form 1116) Deficit

Because Korea assesses very low tax on toejikgeum, claiming the Foreign Tax Credit (Form 1116) in the general income basket only offsets a fraction of your US tax liability. For example, if you receive $60,000 in severance and pay $2,400 (4%) in Korean tax, the IRS will assess tax at your marginal rate (e.g., 24% = $14,400). After the $2,400 FTC credit, you owe a residual $12,000 directly to the IRS.

2. Foreign Earned Income Exclusion (Form 2555)

Severance paid for services performed abroad is eligible foreign earned income under IRC §911. However:

• The FEIE is capped at $130,000 (for tax year 2025).
• If your regular salary during your final year already reaches the cap, none of the severance can be excluded.
• Under IRC §24(d)(3), electing the FEIE for any amount bars claiming the refundable Additional Child Tax Credit for the entire tax year.

The Defined Contribution (DC) and IRP Rollover Trap

Many employers now transfer severance balances directly into an Individual Retirement Pension (IRP / 개인형퇴직연금). While this defers Korean taxes under local law, US citizens must navigate several complex cross-border rules:

• Foreign Grantor Trust Status: Most US practitioners treat Korean IRPs as foreign grantor trusts, which can trigger burdensome reporting on Form 3520 and Form 3520-A unless protected under IRS Revenue Procedure 2020-17.
• PFIC Investments Inside IRPs: If your IRP funds are allocated into Korean mutual funds or ETFs (such as KODEX or TIGER funds), they constitute Passive Foreign Investment Companies, triggering Form 8621 filing obligations and punitive §1291 interest charges upon distribution.
• FBAR & Form 8938: IRP accounts are reportable foreign financial accounts subject to FinCEN Form 114 (if aggregate balances exceed $10,000) and Form 8938.

Strategic Planning Checklist Before Leaving Korea

1. Multi-Year Sourcing Analysis: If you worked in Korea across multiple tax years, confirm the exact service allocation to properly source foreign vs. US income.
2. Departure Date Optimization: Receiving severance in a calendar year with lower overall wage income can keep your US marginal tax bracket lower.
3. Avoid Korean Mutual Funds in IRPs: Opt for standard cash deposit instruments or guaranteed principal accounts inside your IRP to prevent PFIC exposure.
4. Certificate of Coverage & Totalization: Verify your National Pension Scheme (NPS) contributions and secure documentation before repatriating.

Bilateral Context: Under the US-Korea tax treaty (1979) and the US-Korea Social Security Totalization Agreement, double taxation is mitigated through specific mechanisms (such as obtaining a Certificate of Coverage for social taxes). For income tax on severance, double taxation relief relies strictly on the Foreign Tax Credit (Form 1116) or available Foreign Earned Income Exclusion (FEIE / Form 2555) capacity.

Frequently Asked Questions