Large Severance - Tax Shelter Help!

[Dancer]

I need some guidance on how to minimize potential tax hit.  My DH recently left his employer with a solid severance package of around $100K (after automatic 25% tax hit plus, SS, Medicare, state taxes...).  We also get healthcare at employee rate for one year (June 2017 thru May 2018).  He worked for 5 months with gross pay of $46,300 and net pay of $23,300.  The severance offer came up quick, so I put 80% of his pay in his 401(k), but only the last 2 pay periods.  Wish I could have done more pay periods. Lump sum only.
Further deets:
DH is 57 and I am 50
DH will likely not be employed by another employer this year....consulting/contract work probably.
I am self employed with S-Corp- Gross pay around $40K, but pay myself a salary of $12,000/year
We live in a duplex and rent out 1st floor
We have a 3 unit rental property with $2000/month cash flow.
No debt other than mortgages with low rates.

Can we each open up traditional IRA's and then deduct the contributions? OR are we exempt because he was part of an employer contribution plan for first 5 months of the year.  If he remains "self employed" for the rest of the year, can he open up a personal 401(k) or SEP IRA?

Any ideas are appreciated!

[jwright]

I haven't done the exact math, but if you are saying that 25% federal income tax was withheld from the severance, you are going to be close to paid in without doing more.  Try running the numbers like this:



Let's call the bonus $166,667 (assuming 40% tax came out), plus $46,300 for 5 months, plus your $40K from the S-Corp.  I will assume that depreciation reduces rental income to a negligible amount.  That's $252,667 gross. 

I can't tell how much went to the 401k, let's call it $5,000.  Now we are at $247,667. 

Even if you don't itemize, the standard deduction is $12,700 and personal exemptions are $8,100.  Now you are at $226,867 taxable income.  That's without itemized deductions and no deductions for your S-Corp.  The tax on that based on the brackets is about $50,407.

If you withheld 25% on the severance, that's $41,666 paid in.  If you withheld 25% on the $46,000 of salary, that's another $11,500, if you withheld 10% on your $12,000 salary, that's $1,200.

All of that is $54,367 paid in.  You'd be due a refund.

[Dancer]

Thanks, jwright.  I am following your explanation.  There is also the $40,200 in gross rental income to add to that.  I'm hoping that doesn't pop much of our income into a higher tax bracket or AMT (which I don't fully understand yet, but working on it.).  I'll have to watch the numbers closely as we near the end of the year.

Regarding being done with paying taxes because it has already been withheld, I am trying to "claw back" some of it.  $10,662 went into his 401(k) and I regret not being able to take more of his pay from the first 5 months and put it into his 401(k) so that we hit his contribution max of $24,000 for the year and got the company match as well as.

At his age of 57, we are anticipating a possibly much lower income going forward since it may take a while for him to find another job and, when he does find one, it will probably pay much less than his old one.  Hence, the reason we are trying to move as much of this year's gross income into a tax shelter/retirement fund since we may not be able to save as much going forward for retirement.

Thoughts? :)

[Systems101]

Regarding being done with paying taxes because it has already been withheld, I am trying to "claw back" some of it.

I suspect that is difficult in many cases.

If you give to charity, you can consider placing some of the dollars into a donor advised fund and using that for the rest of your life to give.  It would give you a major deduction this year, and then in future years where you have very little income, it would be of no or low value to have any charitable deduction, so it allows you to shift the charitable contribution value into the highest tax bracket.

Just be prepared to fill out the AMT forms :)

[MDM]

Can we each open up traditional IRA's and then deduct the contributions? OR are we exempt because he was part of an employer contribution plan for first 5 months of the year.

See 2017 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work.  Not sure what you mean by "exempt" but that link should cover things.

If he remains "self employed" for the rest of the year, can he open up a personal 401(k) or SEP IRA?

Yes.  See One-Participant 401(k) Plans, and note the $24K limit applies per person, not per job.

[MDM]

Thanks, jwright.  I am following your explanation.  There is also the $40,200 in gross rental income to add to that.  I'm hoping that doesn't pop much of our income into a higher tax bracket or AMT (which I don't fully understand yet, but working on it.).  I'll have to watch the numbers closely as we near the end of the year.

Perhaps the best way for you to estimate 2017 taxes is to take whatever you used (assuming it wasn't "someone else") to do 2016 taxes but use your 2017 estimates.  There will be slight differences in tax brackets, etc., but the actual tax difference will also be slight.

[Dancer]

Thanks, MDM.  By 'exempt' I meant maybe we could not contribute fully to a Traditional IRA because of AGI that either reduce or eliminate the contribution amount permitted.  I will check out your link.  For the Solo 401(k), do you happen to know:  let's say DH does not have any more income for the rest of this year to contribute his remaining $14,000 to a solo 401(k), can he take money from the severance payout and put it into a solo 401(k)?  And would that result in a deduction or tax credit since it has already been taxed?

Systems101- we would consider that option as well based on how things look at the end of the year :)

[MDM]

...let's say DH does not have any more income for the rest of this year to contribute his remaining $14,000 to a solo 401(k), can he take money from the severance payout and put it into a solo 401(k)?

No.   See One-Participant 401(k) Plans under "Contribution limits for self-employed individuals".

[Dancer]

Got it, thank you.