Supplemental Wages & Taxes: How Are Supplemental Wages Taxed?

by | Jun 27, 2019 | Financial Independence, Tax Planning, Tech Industry

Supplemental Wages & Taxes: How Are Supplemental Wages Taxed?

by | Jun 27, 2019 | Financial Independence, Tax Planning, Tech Industry

supplemental wages

In the tech world, it happens all the time:

Employees get supplemental wages beyond their base income. They file their tax returns, reporting these wages just like they’re supposed to. And then they end up with huge tax bills because the withholdings their employer took out of their paychecks weren’t enough. ????

It sucks.

And leaves a lot of people wondering what they could have possibly filled out wrong on their W4… or if their HR and finance offices just aren’t playing by the rules and screwing them over in the process.

But don’t worry.

Chances are, you didn’t do anything wrong in your tax paperwork, and everything your company is doing with your money is according to the rules.

And that’s what we’re going to explain in this article… and also give you some advice on avoiding a massive tax bill when you’ve got a lot of supplemental wages to report.

Supplemental Wages vs. Regular Wages

By definition, supplemental wages are anything your company pays you beyond the regular, predictable paycheck you get from them (your regular wages).

In the restaurant and service world, tips are considered supplemental wages, for example.

But in the tech industry, these can be bonuses, restricted stock units, nonqualified stock options, or commissions if you’re a sales rep. So, in reality, most tech employees will have to report some type of supplemental wages at one point or another.

And because these wages are “supplemental,” meaning they’re above and beyond your regular, agreed-upon salary, they’re treated differently in tax withholding… which is why they cause such a surprise come tax time.

The IRS’s Supplemental Wage Withholding Rules… & Why They Kind of Suck for Tech Employees

When you’re company pays you a supplemental wage, they don’t withhold at the same percentage rate that they do with your normal salary.

As you probably know, your normal wages have taxes withheld based on two things:

  • The IRS Withholding Tables
  • The allowances you do or don’t give yourself on your W4 (like if you’re married or have children, for example)

And essentially, the more your normal wages scale up, the more your withholdings scale up along with them… so that ideally you don’t owe anything at tax time.

But with supplemental wages, the withholding amount is usually only two possible percentage points:

  • 22% if you have less than $1 million in supplemental wages
  • 37% for anything over $1 million in supplemental wages

The problem comes, though, when you realize that the 32% tax bracket (10% higher!) starts at just $160,725 taxable income for single taxpayers, and $321,450 for married couples. With these numbers, the instant you cross the 22% tax bracket threshold, you immediately owe more on your supplemental wages than your company has withheld.

If your company pays you more than $1 million  in supplemental wages, then they’ll start withholding 37% after the $1 million mark… but will still only withhold 22% for the first $999,999.99 of those supplemental wages… so you’ll still owe a good deal on taxes.

 

Three Ways to Avoid a Huge Supplemental Wages Tax Bill

Fortunately, there are things you can do to get ahead of a huge tax bill from supplemental wages, so you don’t get slammed at tax time.

  1. Adjust Your Withholding Status & Federal Allowances

Technically, when you adjust your withholding status and federal allowances, you’re only doing it on your regular wages. However, it does ensure that more money gets withheld from your paycheck, contributing to making up the difference between what gets withheld from your supplemental wages, and what you actually owe.

On your W4, adjust your status to single (even if you’re married), and set your federal allowances to 0.

And yes, you’re allowed to do this. This isn’t an official record of your marital status for a census, it’s just a way of telling the government whether or not you want to receive the tax benefits of being married (or having children, for example, if that’s one of your allowances) throughout the year.

And while this will help you out by increasing the withholdings on your regular wages, it still may not be enough to cover the gap of what’s withheld and what you owe on your supplemental wages.

  1. Make Estimated Tax Payments Before Tax Time

You don’t actually have to wait until April to pay your taxes. You can make a payment towards what’ll you’ll owe any time on the IRS website.

This is a great way to break up the burden of a large tax bill throughout the year, rather than having to pay it all at once.

It’s a good idea to work with your accountant or financial advisor to determine how much you should pay and when.

(In fact, I often advise my clients to make payments after selling RSU shares, getting a bonus, or after a same-day sale of NQSO. This helps them make sure they’re paid up on their taxes, so they can fully enjoy the money they make from each of those events without having to worry about being slammed with a nasty tax bill after the first of the year. If you’d like to talk to me about this, book a call with me here.)

  1. Ask Your Company to Withhold More

This won’t always be possible, but some companies will work with you to withhold more than the 22% base withholding on your supplemental wages. Google, Pinterest, and Slack are companies that have been known to do this, so it’s at least worth checking with your HR and finance departments.

If they are willing to work with you and withhold more, you need to figure out how much additional you want them to withhold. To do this, go to your last year’s tax return, and figure out which taxable income bracket you landed in.

If you landed in the 35% tax bracket, subtract 22 (the percentage that’s already being withheld) from 35 to get an additional 13% of withholding.

Once you have this number, you’ll elect a 13% voluntary withholding on supplemental wages to bring you up to the 35% so you won’t have a massive, unpleasant surprise at tax time.

 

Beware of Incentive Stock Options

These guys are the grim reaper of supplemental wages, and can really take you out at tax time if you’re not careful enough to plan ahead.

The thing is, ISOs have no statutory withholding requirement. So, even if you do a same-day sale, your company may not withhold anything for you, and all the money you make from that sale will be taxed as ordinary income. (But, since nothing’s withheld, that’s an amount you’ll have to pay out-of-pocket when you file your taxes… unless you pay estimated tax in advance.)

ISOs and taxes can be tricky, and we’ve got a great article on ISO and AMT under the new tax plan here.

 

Make Sure Your Supplemental Wages & Taxes are Sorted Out

Now that you know how supplemental wages work with federal taxes and company withholding practices, you can at least plan in advance to take care of yourself come tax time.

Believe me, I know there’s nothing worse than realizing you owe a massive amount of money to the IRS right at a time when the weather’s starting to warm up and you’re dreaming up nice summer vacation ideas.

To make sure you have your tax bill for your supplemental wages taken care of, and to make sure you’re making the most of your financial options as a tech employee, set up a call with us. We’ve helped lots of people like you get ahead of their finances and create wealth for a secure financial future, and we can help you too.




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