Meet Sally Jones, a young advertising professional in NYC who just landed a big promotion. Along with her new role, her pay structure changed to include a base salary plus a potential bonus of up to $50,000. Sally was thrilled with her success until April 15th, when she faced a large, unexpected tax bill.

What Went Wrong?

This is a common issue for high-income earners in New York City. Here’s what happened to Sally:

  1. Base Salary Tax Withholding: Sally’s base salary of $150,000 is taxed regularly, with her employer withholding taxes based on her W-4 settings. Sally is in the 32% tax bracket, so her bi-weekly withholdings align with this rate.
  2. Bonus Tax Withholding: Things got complicated when Sally received her $50,000 bonus. The IRS considers bonuses as “Supplemental Wages,” which are taxed differently from regular wages. Instead of being withheld at her usual rate, the bonus was taxed at a flat rate of 22%.
  3. Underwithholding Issue: Since Sally’s overall tax bracket is 32%, her bonus was under-withheld by 10%. She had to pay the difference when tax season arrived, resulting in an unexpected tax bill.

How to Handle Bonus Taxes in NYC

If you’re a high-income earner like Sally, especially in the top 37% tax bracket, here’s what you can do to avoid these surprises:

  1. Understand the Issue: Be aware that bonuses and other supplemental wages (like stock grants/RSUs and stock option exercises) are taxed at a flat 22% rate, which might be lower than your actual tax bracket.
  2. Adjust Withholding: Opt for a one-time election during the week you receive your bonus. In your HR system, select the Supplemental Withholding option and have your employer withhold at the higher 37% rate. This may be the only alternative rate available in your HR system. If you overpay, it will come back to you at tax filing time.
  3. Estimated Tax Payments: Calculate the extra tax you’ll owe on your bonus and make quarterly estimated tax payments to the IRS throughout the year to cover the shortfall.

Navigating Tax Changes

The 2017 tax law changes also impacted withholding calculations. Previously, settings like “Single with no dependent exemptions” resulted in higher tax withholdings and often a refund. Now, standard withholding is akin to “Single with 2 dependent exemptions,” which may lead to a break-even situation or even owing taxes at year-end.

The Best Solution: Consult a Tax Professional

Working with a tax professional in NYC who understands these nuances can save you from unexpected tax bills. Meet with them before the end of the tax year to project your taxes accurately. This preparation ensures you’re not caught off guard during tax season and can make informed decisions about your income and withholdings.

By understanding these tax nuances and planning, you can enjoy your well-deserved bonus without the stress of a surprise tax bill.

 

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