How is Israeli severance pay taxed for a non-resident employee?

An employee who worked for an Israeli company and then left the country — or a foreign worker whose Israeli posting ended — often receives a severance payment and wonders whether Israel will tax it, whether their new home will tax it again, and who is responsible for withholding. Severance sits at an awkward intersection of Israeli employment law and tax law, and the answer depends on years of service and on where the work was done.

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Detailed Answer

Severance pay (pitzuyei piturim) in Israel arises from the Severance Pay Law 1963, which entitles an employee dismissed after at least one year of continuous service to roughly one month's salary per year worked. The tax treatment of that payment is governed by the Income Tax Ordinance 1961. The key provision is Section 9(7A), which exempts severance from tax up to a ceiling set per year of employment. Below that ceiling, the payment is tax-free in Israel; the portion above it is taxable, either at the employee's marginal rate or, by election and approval, spread or averaged to reduce the rate.

The exemption ceiling is indexed and updated periodically. As a working figure, the exempt amount is capped at the lower of the employee's last monthly salary or a statutory limit (in the region of NIS 13,750 per year of service in recent years), so a long-serving employee on a modest salary may receive the entire severance tax-free, while a short-serving high earner will see part of it taxed. The Israel Tax Authority (Rashut HaMasim) sets the indexed figure each year, and the exact number for the year of termination should be confirmed.

For a non-resident, the threshold question is source. Israel taxes non-residents on income produced or accrued in Israel. Severance that compensates for employment physically performed in Israel is Israeli-source income, so it remains within the Israeli tax net even if the employee has since moved abroad and the payment lands after departure. The employer is required to withhold tax at source on the taxable portion under the withholding rules in the Ordinance, and the employee receives the net amount with a withholding certificate. Where the work was performed partly abroad, an apportionment may apply.

Because the same payment can also be taxable in the employee's country of residence, double taxation is a real risk, and relief usually comes through the relevant treaty. Many of Israel's tax treaties treat termination and severance payments as employment income taxable where the work was performed, with the residence country giving a credit for Israeli tax paid. The result is often that Israel taxes the non-exempt portion first and the home country credits it, but the mechanics vary by treaty. The general framework for how Israel taxes non-residents' Israeli-source income is set out in the guide on Israeli income tax for non-residents.

In Practice: Under Section 9(7A) of the Income Tax Ordinance 1961, severance pay is exempt up to a ceiling of roughly NIS 13,750 per year of service (the indexed figure is set annually by the Israel Tax Authority), with the excess taxed at the employee's marginal rate unless spreading is approved. The employer must withhold tax at source on the taxable portion and issue a Form 161 settlement; obtaining a tax ruling or spreading approval from the assessing officer typically takes 4 to 10 weeks. A non-resident whose work was performed in Israel remains liable to Israeli tax on the non-exempt portion even if paid after leaving the country.

Key Considerations

• The exemption is per year of service up to an annually indexed ceiling — long service with modest pay often means little or no tax
• Severance for work performed in Israel is Israeli-source income and stays taxable in Israel after you leave
• The employer withholds tax at source on the taxable portion and issues a withholding certificate
• The same payment may be taxable in your country of residence, with relief through the double-tax treaty
• Electing to spread the taxable portion over several years can lower the effective rate, but needs Tax Authority approval

When to Consult a Lawyer

This question typically requires professional legal advice when:

• Your severance exceeds the exemption ceiling and you want to minimise tax through spreading or a ruling
• You performed the work partly in Israel and partly abroad, raising an apportionment question
• Both Israel and your country of residence are taxing the payment and you need to apply treaty relief correctly

A qualified Israeli tax attorney or accountant should review your Form 161 and the treaty position before you accept the employer's withholding as final.

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Speak With an Israeli Attorney

Severance withholding is often applied bluntly by payroll, and non-residents overpay because no one claims the exemption or treaty relief properly. We can review the calculation and recover or reduce tax where the law allows.

Contact us for a confidential initial consultation.