No, you don't allocate. The severance pay is fully taxable in Kentucky. The reason why is that the severance pay is like receiving "belated wages" (wages after the fact) from services performed in Kentucky. That is taxable in Kentucky. Unemployment benefits are not taxable in Kentucky if you live outside of Kentucky. Retirement benefits are not taxable in Kentucky once you start receiving them in another state (even if you worked for a KY company previously). But Severance pay is taxable in Kentucky, and that is why KY required the company to withhold KY tax on that income.
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