Fixing Tax Problems for Bonuses , Stock Compensation, and Dual Income

Some executive-level clients have recently reached out to me regarding questions and problems with their estimated taxes. The second installment of estimated taxes is quickly approaching (June 17th) so understanding where and how much to pay is very important. In our conversations, it is clear that even worse than paying taxes is the surprise of paying a lot in April and having to pay a penalty on top of that. In this post, I’ll share a few tips and tricks to clarify the tax mystery and not fall behind on your estimated payments.

For executives or taxpayers with income beyond a base salary, wages can fluctuate dramatically year-to-year. Bonuses and stock compensation change each year based on company/individual performance, stock price, and tenure with the company. The tax law itself exacerbates the tax problem by withholding too little on these types of earnings - only 22%! No wonder people are shocked with big tax bills in April.

Are both spouses in higher performing positions? Being a dual income household is another situation where taxes can be under-withheld on your paychecks and cause surprise taxes and penalties in April. It’s like drinking lemonade without the right balance of water, lemon juice, and sugar - too watered down or too sour to enjoy. Finding the right balance of income and tax withholdings helps your cash flow work much better.

Let’s look at two simple things an executive or dual income taxpayer can do to get a better handle on their estimated taxes.

Executive Compensation or “Supplemental Wages”

Is your annual income greater than $300,000? Did you receive a bonus, exercise stock options or receive vested restricted stock units (RSUs)? If yes, then you are likely underpaying your taxes.

Many people in this situation ask why they owe taxes in April or need to pay estimated taxes. The biggest reason for underpayment is that “supplemental wages” have a 22% tax withholding rate. By law, this rate cannot be changed. Ridiculous, right?

This 22% rule is harmful to taxpayers with income between $300k and $1 million because their tax rate generally falls between 32% and 37%. This system is setting them up to owe a surprising amount of money in April - and a possible penalty. Once a taxpayer’s income exceeds $1 million, the supplemental tax withholding rate increases to 37% and the tax underpayment is mostly eliminated.

So here’s the quick fix: Pay 10% of your gross supplemental income to the IRS for estimated taxes. You can go online to pay here https://www.irs.gov/payments/direct-pay or mail a check using the payment vouchers and addresses included here https://www.irs.gov/pub/irs-pdf/f1040es.pdf.

Dual Income Households

Do you and your spouse have higher income positions (greater than $100k)? Have you updated your tax withholdings to 0 allowances, but still wonder why you owe taxes every year or need to make estimated tax payments? Having to make these extra tax payments can be a pain and make it difficult to know how much of your income is yours versus how much needs to go to the IRS.

The IRS tax withholding system is the source of this problem. The payroll and tax system does not know that your spouse is also a higher income earner. The “married” status on your paycheck and W-4 refers to the married tax brackets and standard deduction as if you are the ONLY wage earner.

So here is a quick fix: On the IRS form W-4 “Employee’s Withholding Allowance Certificate”, check the box for “Married, but withhold at higher Single rate”. Since the single income tax table and the standard deduction is roughly half of those used by married taxpayers, this adjustment may fix your April tax or estimated payment problems going forward (not past paychecks).

Beyond supplemental wages and dual income taxpayers, other estimated tax situations generally include self-employed taxpayers and people with investment income. After considering these quick fixes, it is a good idea to get professional assistance for managing your estimated taxes and personal long-term tax strategy. Having clarity, understanding, and strategy around your taxes are key ingredients for your financial plan.