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HPAlumnipedia > Leaving > Taxes > Deferrals

Alan Silverstein, Fall 2002:

When it was clear my own layoff was imminent and I would probably receive a large taxable severance bonus that year, I starting looking for ways to minimize my tax hit that year. Initially I only thought of the first three ideas listed below (401(k), capital losses, 529 plan), but later I learned or was reminded of several others. Some are fairly standard tactics along the general lines of, "accelerate deductions and defer income," that I'd simply overlooked.
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• HP 401(k) Plan (was TaxCAP): Maximize your contributions as soon as possible, if you can afford to do so, such that you max out ($15,000 in 2007) with your last expected paycheck (at termination) without going over (at least not much), and keeping your contribution over 5% to get the full (4%) company match. (You might have to dip into savings and restore them after you get your severance.) Check the latest rules to ensure you optimize the matching. Note that you probably won't get the "true up" of the company match that started in 2003 if you're no longer an employee on Dec 31. Note that no 401(k) deduction is taken from your severance pay.

Tom von Alten, Dec 2003:

I was informed (too late to do more than get lucky, for half of the opportunity) that both regular earnings and vacation payout are eligible for the 401(k) deduction. The company match will not exceed your contribution for the pay period, however. If you have a sizeable accumulation of vacation, you can get a significantly larger company match than the normal 4% of regular earnings. Here's how:

1. Estimate your "maximum company match" for the last paycheck as 4% of (regular earnings + vacation payout). Note that "regular earnings" in your last pay period may be for less than 87 hours.
2. Plan your 401(k) contributions such that you hit the IRS limit with at least 5% of your last regular earnings and vacation payout. Hopefully this as much as you estimated in the first step.

For example: You have $3500 regular earnings (and a full period for your last check), and 6 weeks of banked vacation, worth about $10,000. The max match is 0.04 x 13,500 = $540, $400 more than the $140 you usually get as 4% of the $3500 earnings. Make sure you're at least $540 short of the IRS limit for the last pay period. If your contribution is set to 5% or higher, you'll get the maximum contribution the IRS allows, and a company match as large as your contribution.

Alan Silverstein, Fall 2002:

All dollars contributed are federal and (most?) state tax deferred, however, still subject to FICA (Social Security). And, calculate your pay periods remaining carefully, including the final period; I had an off-by-one error.
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(Contributions to traditional IRAs are another way to defer income tax, but most HPites do not qualify due to 401(k) plus income limits. Consider a contribution to a spouse's IRA if he or she's not working or doesn't have a 401(k).)

• Capital loss: Sell stock, mutual funds, etc. this year at a $3000 loss (maximum you can claim in one year). You can always buy back the same assets 31 days later, hopefully at the same or a lower price, to keep your position, avoid a "wash sale", and "lock in" your loss (with a new, lower cost basis). If you have stock at an online broker, know how to play stock options, and have time before the end of the calendar year, it can be entertaining and even lucrative to sell "covered call options" for a while instead of directly selling the stock at a loss.

• 529 education plan: You can defer some state tax -- in fact, exclude it completely if you withdraw the money for qualified purposes (at least in Colorado) -- by opening a 529 plan. Also, federal taxes on any gains are also now (starting in 2002) exempt for qualified withdrawals.

Alan Silverstein, Fall 2002:

For example, I set aside some of my severance bonus to help my daughter finish college. In Colorado visit the Colorado state website to get started.

• Schedule C: As soon as you act as an independent consultant, apparently you can file Form 1040 Schedule C for that tax year and take deductions for legitimate business expenses. There are a lot of possible deductibles, although the paperwork can be daunting. If you are looking for a job, your expenses above 2% of your AGI can be deducted on Schedule A, but to the extent you consider yourself already a private businessperson (consultant), your expenses of looking for work to do is directly deductible (no 2% floor) on Schedule C.

• Prepay taxes: (Thanks to Hein Vandenheuvel for this and similar suggestions.) If you own real estate and pay your county property taxes directly rather than through escrow (or maybe even with the latter if you can work it out with your mortgager), and if this puts you above the standard deduction so it's worth doing, visit your county treasurer before the end of the tax year and prepay some/all of your taxes due the next year. The only catch is probably that you give up next year's deduction unless you continue to prepay early in future years.

Alan Silverstein, Fall 2002:

In Larimer County, Colorado, I found this very easy to do in Dec 2002. I visited the "Treasurer" office in the courthouse and chatted with a clerk who looked up my address and told me my estimated tax due next spring. I wrote a check and got a receipt.

• Prepay interest: Similarly, in some cases you might be able to prepay mortgage interest and gain a tax deduction benefit.

Wayne W Cook, Dec 2002:

In most cases, you can pay January's bill in December. I tried to pay both January and February 2002 payments in December 2001, for reasons obviously not related to WFR ;-). The company would only accept the January payment. They held the February payment until February. Check with your mortgage company before making anything but the January payment in December. 8-(

• Prepay charitable contributions: Similarly, if you regularly donate to charity anyway, consider doubling-up in the year you receive your severance bonus. In fact if you are typically "near" your standard deduction, timing contributions and similar deductible payments can benefit you by allowing you the standard deduction and a higher deduction, in alternating years. Some counties collect property tax early/late in a tax year, which can also allow you to time your payments by tax year. Also consider "charitable gift funds", such as via Fidelity or Vanguard. You can set aside money now, take the deduction, and dole it out later.

Tom von Alten, Aug 2003:

We set one up a while ago for its "regular" tax benefits, including enabling syncopating charity across tax years (more one year, less the next). I thought I might be able to use the standard deduction in the "off" years... (I don't know what chapter and verse these things are based on, but Fidelity's is called... "The Charitable Gift Fund.") ...You donate money (or, preferably, appreciated securities) and get the charitable deduction in that same year. Fidelity invests it in large, diversified fund portfolios... per your specification and management, but it's no longer yours, or retrievable. You make requests to donate to your desired charities, and if they're legit (per Fidelity; hasn't been an issue for any of mine), Fidelity sends the money. You're not supposed to use them to fulfill pledges, so for organizations we used to pledge to, we modify forms by crossing out "pledge" and writing in "we'll do our best to contribute $X." Fidelity's has a minimum amount of $250, if I recall right, and it can't be for anything that returns partial value. (The local art musuem gives free entrance and discounts at the store, so a $300 contribution is only like $260 for tax purposes -- can't do that.)

• Later, convert to a Roth IRA: If you find yourself with little taxable income for an entire calendar year after leaving HP, and you have substantial traditional IRA assets, consider converting them to a Roth IRA. You must pay tax on the rollover now (at a low marginal rate), but then the principal and any future gains are tax-free (for qualified withdrawals). Sorry but you'll have to look elsewhere for the details.