What can I do to minimize my taxed income (without underpaying) when I receive a $72K severance paycheck (1/2 annual pay) after being laid off?

[gr8st8ofWA]

Current filing status is Married Filing Jointly, no dependents.

[MarilynG1]

One of the best ways to reduce taxes is to contribute to a retirement account.

Click this link for several tips to Lower Your Tax Bill you should find helpful. 

[gr8st8ofWA]

Thank you, that's a great suggestion. I'll likely do that once I find another job, but would hate to incur a penalty if it takes longer than expected to find a job and I needed to pull funds from my retirement account.  

In the past, when I recv'd an annual bonus, it seemed like the amount taxed increased, as if I was making that higher amount on every paycheck. I'm not sure what taxable bracket I'm in, but my average federal tax taken from my paycheck was 11.4% (based on simple division from the amounts on my final 2022 paystub). The paycheck in 2022 where I received the bonus, the federal tax taken was 18.6%.  Perhaps a "Bonus" falls into a different taxable category than normal pay.  If that's the case, what category does the severance pay fall under?

[JohnB5677]

Wages, bonuses, and severance pay are all considered earned income and taxed the same.  The IRS has a progressive tax.  This means that the more you earn, the higher your taxes and tax bracket.   When your bonus was paid at the higher tax rate, it is probably because your company had factored in all of your previous earnings. 

Also, Payroll services withhold taxes based on what they think you will make for the year.  

• If you earn $5,000 a month, they will project that you will earn $60,000 in the year.  
• They then subtract the deductions you indicated on your W-4 or the standard deduction
• They  estimate the tax for the entire year.
• Then they allocate the tax on a weekly, or monthly basis.
• A bonus or severance pay is not a planned income and wouldn't be included in the previous calculation.
• Therefore, they would be taxed at the full tax rate for your total income.

[dmertz]

About the only way to reduce 2022 taxable income in 2023 is to make a deductible traditional IRA contribution or an HSA contribution, if eligible.  Keep in mind, though, a deductible traditional IRA contribution just defers taxable income to some future year and will be taxable when you eventually take that money out of the IRA.  If your marginal tax rate in the future is not expected to be less than it is now, you might as well just pay the taxes now.

It makes no sense to take money out of a retirement account just to make a contribution to a retirement account.  To be of any benefit, the money would have to come from somewhere else, say, the severance payment.

Bonuses and severance pay are supplemental wages reportable on your W-2.  Tax withholding might be calculated differently on bonuses and severance pay than it is on your regular pay, but in the end that usually doesn't matter much because your tax liability is unaffected by the amount of your withholding unless under-withholding results in an underpayment penalty.