Ideas For How to Minimize Tax Consequences of Surprise $100k "Income"

Background: For tax year 2022 and 2023 I am intentionally making as little income as possible in order to qualify for significantly cheaper medical insurance rates. I will turn 65 late this year and will then get on Medicare + supplemental and after that I will not try to intentionally keep my income super low.

My income for tax year 2023 was going to be $18k which puts me in a 12% federal income tax bracket.

But then I got a phone call from my old boss where I worked for over 15 years. She has sold the business and gave me $100k from the sale as a thanks for the role I had played in helping grow the business when I worked there. (The $100k will be reported as a 1099 from their side, so I can't even deduct some of it as a gift.)

Needless to say I was honored, surprised, humbled and grateful for the $ and the generosity of my ex boss.

But now I have a significant tax hit that goes something like this: Federal income tax on my original $18k would be $2,160. Federal tax on the new gross income of $118,000 will be $28,320 so that's a $26,160 increase not including the similar consequences from the state tax. But wait, there's more! The change in reported income will eventually get noticed by our buddies at Healthcare.gov and they will probably come back at me for increased medical insurance premiums for 2023. I may be wrong but I think the increase will be about $1,000-1,300 per month - so worst case that's another $15,600 "expense" that will result from this event. 

So all in I think that unless I do something creative, I will spend an extra $41,760 (plus state income tax) - so let's just round up and say that about $50k will disappear from "my" $100k windfall.

What could I do before the end of this year to mitigate some of this? Or, what could I do "soon" that would eventually make back some of the "lost" $50k in extra taxes down the road in later tax years?

I only have the standard advice:  tax shelter as much as possible

Do you have a 401k?  You can shelter $20kish right there

IRA?  You should be able to shelter $7500, $15k if you are married and your spouse can shelter as well

HSA?  there's another $3500-7k

*contribution limits subject to what plans you have access to, etc.

Insert the usual disclaimer about me not being a CPA here. :)

Are the insurance rates based on AGI or on taxable income?

Did you have a 401(k) or a HSA at that job?  If so, can you direct some of the windfall into those accounts?  Those sorts of accounts are pretty much the only way to reduce AGI.

If it's based on taxable income then IRA contributions or gifts to charitable organizations will create deductions that offset it to a degree.

Keep in mind, if you get a 1099, not only do you have to pay income tax but you may also have to pay the employer's share of taxes as well as unemployment taxes and such. 

You are going to have to sit down and talk to a professional.

Not a CPA, but initial  thoughts:

Any capital  losses you can sell? No idea if  this will impact a 1099

Can  your former boss delay gifting it to you, or does it have to happen this year?

Find a way to make it capital gains rather than ordinary income. Better yet, find a way to get the small business stock exemption from capital gains Section 1202

its definitely worth a couple hundred bucks to talk to a tax attorney on this.

Yes, very thoughtful of your former boss. Can she send the check next year?

Go see a tax accountant, see several as not all of them are good.  One or 2 will have a good plan.  

CALL. A. CPA.

End of discussion. 

porschenut said:

Go see a tax accountant, see several as not all of them are good.  One or 2 will have a good plan.  

In reply to calteg :

I wanted to delay the payment until next year but she had to do the transaction this year for her own reasons.

Set up a trust to take the $$$

I am not a CPA either, but I did just retire and am carefully dealing with the health insurance issue (unfortunately not the "surprise $100k" issue).

I was going to suggest a donor-advised fund (assuming that you give money to charity anyway, you can give away a big chunk and write it off in one year then dole it out to charities over multiple years).

However the premium subsidy is based on AGI and charitable donations are deducted after AGI.  The only things I remember that reduce AGI are 401K, IRA, and HSA, as mentioned earlier in the thread.

alphahotel said:

However the premium subsidy is based on AGI and charitable donations are deducted after AGI.  The only things I remember that reduce AGI are 401K, IRA, and HSA, as mentioned earlier in the thread.

IRA is just a deduction, it does not reduce AGI.  HSA does for federal taxes but state laws vary (here in CA, for example, HSA does not).  401(k) does everywhere, as far as I know.

First world problems, eh?

like others - get the right people to discuss 

can you donate the large chunk to a charity that is equal to taxes?  Somehow help out a charity cause you're paying either way?

Set up a trust or a LLC and have the check made out to it. I know you can also adjust past returns and claim some income on those, but as others said, talk to a pro. Spend $500 for them to save you $45k. If it's 1099 you will pay both sides of SSI so it can get spendy v

Thanks so far for the excellent comments! CPA meetings and IRA/401k sheltering are solid suggestions and certainly a path I will follow.

But now, just for S&G's - let's introduce another strategy!

What about I start an intentionally real business (as opposed to one that I never want to succeed) and it throws a significant loss this year as it starts up? The losses are roughly in the $30-50k range (and offset most/all of the tax hit on my personal income). Then in years +01 or even later, it starts to throw a profit and eventually makes even more money - a fitting tribute to the spirit of the gift she gave me this year. Everyone wins. I make money and have fun. The government makes more money off the business taxes down the road than they would have made off the single year $50k that I am currently facing.

So it's easy to write something like what I just did, but it's not really that simple. What are the issues besides normal business risks? 

In reply to Sparkydog :

So are you saying you'd plow some of the windfall into capitalizing the business, which of course will not recoup this in the next 4 months, thus generating a loss?  To my (non CPA, non tax lawyer) mind this sounds like it has potential..

If there's a depreciation schedule on the capital items, that may eat the gain back in future years, but as you say, you may not care.

Section 179 deductions allow for full write offs of capex to a certain limit on certain things. Have used it, works. Consult a pro. 

Sparkydog said:

Thanks so far for the excellent comments! CPA meetings and IRA/401k sheltering are solid suggestions and certainly a path I will follow.

But now, just for S&G's - let's introduce another strategy!

What about I start an intentionally real business (as opposed to one that I never want to succeed) and it throws a significant loss this year as it starts up? The losses are roughly in the $30-50k range (and offset most/all of the tax hit on my personal income). Then in years +01 or even later, it starts to throw a profit and eventually makes even more money - a fitting tribute to the spirit of the gift she gave me this year. Everyone wins. I make money and have fun. The government makes more money off the business taxes down the road than they would have made off the single year $50k that I am currently facing.

So it's easy to write something like what I just did, but it's not really that simple. What are the issues besides normal business risks? 

I actually wrote a post suggesting this, but didn't post it because I think you need the input of an accountant (and I am not an accountant). 
 

I like the basic concept. 
 

If you started an LLC, would your friend make the 1099 payable to your business, or is she only willing to make it payable to you personally?

It sounds like you contributed significantly to her business, and that she does not consider this a gift (because she is issuing a 1099).  That could make it earnings for a business.

Depending on documentation and timing, the section 1202 I posted above may be a real option. The exemption is 100% up to $10M.

Sparkydog said:

What about I start an intentionally real business (as opposed to one that I never want to succeed) and it throws a significant loss this year as it starts up? 

Were you planning on starting a business anyway?  If so then it sounds like the timing is fortuitous.  If not then it sounds like an awful lot of work just to avoid some insurance premiums.

Question: Would taking the extra $100K as income help significantly raise your Social Security earnings benefit once you start collecting? I believe they take your top XX years of inflation-adjusted income to determine the monthly amount you can receive. Might be worth the tax penalty this year if it significantly increases your monthly amount in the future. IDK, I'm no CPA.

That's true. It does affect SS.  But probably not significantly. 
 

IIRC, they take your 35 highest earning years and average them.  So, 1 high year has an impact, but it's averaged over a lot of years. 

When my surprise $100k arrived, I...

...oh, wait, that was a dream.

Congrats!

I hope this is the greatest problem you are facing in your life.