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 By George Durham,
A lump-sum settlement package received as part of an employer’s reorganization effort can be a quick boost to retirement savings, but income infusions aren’t without tax implications that should be considered carefully.
If a lump-sum payment makes your total annual income higher than it was last year, some credits or deductions that you normally claim may be reduced or unavailable.
Companies who provide lump-sum severances are required to withhold 25 percent to cover federal income tax and more for Social Security and Medicare. Some states also require that state income taxes are withheld. But the mandatory withholding might not be enough to cover what you’ll owe at tax time. Making estimated payments and increasing the amount withheld could help in the long run. If the severance pay doesn’t come in all at once but rather as several checks, federal and state tax won’t automatically be withheld.
As for unemployment benefits, withholding can be requested during the application process, but rules differ by state. An H&R Block tax professional can help you sort through the changes. Besides money, if you are no longer working and your family’s income has decreased, you may be eligible for federal or state programs that can help. If necessary, H&R Block tax professionals may be able to refer you to agencies that offer nutrition and medical assistance, help with heating and utility bills, emergency home repairs and other critical services.
Regardless of how you leave a job, you need to be aware of deadlines for rolling retirement funds over to an IRA or other retirement account. To eliminate the requirement for income tax withholding and ensure you aren’t taxed or penalized for early withdrawal, it’s best to have the trustee of the current plan make the check out directly to the trustee of the plan where the funds will be rolled, not to you personally.
If a distribution is made to you, you will have 60 days from the date of receipt to roll over the funds. You’ll need to make sure you roll over the exact amount of the full distribution to avoid paying penalties.
Incentive stock options (ISOs) are another benefit to consider. Under the federal income tax system, you are not taxed on ISOs if they are exercised and held. The income tax applies once you have sold the acquired stock.
However, the Alternative Minimum Tax rule is different. When stock options are exercised and shares are held for the remainder of the year, the difference between the price you paid to exercise the options and the current fair market value of the stock at the time of exercise is considered income for AMT purposes. This means that if you exercise a significant amount of ISOs in one year, you can potentially trigger the AMT. Therefore, it may be better to exercise your ISOs over several years or plan for the additional tax that you may owe. Because of the complex implications, H&R Block tax professionals and financial advisors can help maximize the benefits from your stock options, especially because there may be a quick deadline for you to exercise them.
If and when you look for another job, any moving expenses incurred may be deductible, even if you don’t itemize. To qualify, your move must meet these rules:
1. Related to start of work: The move must be closely related to the start of work, generally within one year before or after you start working in the new location. It’s not necessary for you to have acquired the job before you move.
2. Distance test: Your new main job location must be at least 50 miles farther away from your old home than your old job was from your old home.
3. Time test: You must work full-time for at least 39 weeks out of the 12-month period starting when you arrive at the new location. The weeks don’t have to be consecutive, and you don’t have to work for the same employer.
Regardless of the circumstances, consulting a tax or financial advisor can help you make sound investment decisions based on your long-term financial goals.
George Durham is an H&R Block tax professional in Nashville. You can reach him by calling 615-834-2586.
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