0 withholding on bonus, throwing into the S&P
Hi - Random compensation question that I've just dreamed up:
Imagine you are compensated at the beginning of the year (Jan 2022) with your bonus, say $300k. Instead of getting automatic withholding on your bonus, say 50%, you take the bonus in full - $300k straight to your account - and invest the money that you will owe in taxes in 2023 into the S&P with an expected return of 10%.
In Jan 2023, 1 year later, you cash out your $165k, pay 15% long term cap gains tax (~2.5k), and pay the income tax that you would have paid last year, coming out ahead on the difference, in this case an extra ~13k
Is this extremely unrealistic or is this something that people have done in practice?
No company will allow you to do 0 withholding.
also you’d be subject to interest and penalties.
Where are you getting these from?
Withholding amounts are an election made by the employee.
Yes you’d get penalized, but a very small amount and only by local and state tax authorities. I’m talking $100 bucks.
Interest on what loan?
The federal government certainly requires estimated tax payments if you don't withhold enough. Exactly how much estimated tax you need to pay is complicated but if you underpay by more than 100k it is highly unlikely the interest and penalties for underpayment would be 100 or less. If for some reason your employer didn't need to withhold (self-employment or working abroad) and you made much less the previous year then it is possible you wouldn't need to pay much estimated tax on the bonus.
On the other hand if you are assuming 10% return in S&P 500 you might as well just buy S&P 500 futures or leveraged ETFs or a margin loan to capitalize on the 10% gain.
Withholding is an election made yes. But the least you can elect IS NOT 0 as far as I’m aware. You can elect a handful of exemptions which will reduce withholding some but will not eliminate it entirely.
On your taxes the following year, if you significantly underwithheld, the government will charge you interest and penalties. This is also true if you have large non w2 income (think K1 or 1099) and you don’t submit estimated tax payments during the prior calendar year.
Rather than throw MS, how about just starting a constructive dialogue / asking a question.
Have you thought through the scenario where the S&P is not up 10%, but say down 20%? How do you pay the IRS then?
Plus, as HFPM said, your employer is legally required to withhold. Genius ideas like this are why people end up broke.
If you’re extremely disciplined, there’s a chance could pull this off. It would be damn risky though. You don’t want to owe taxes that you can’t pay back immediately. The federal government has no problem letting private loans default…but if they don’t get their tax money? They quickly show their true colors
It is not an election its only an election when you get canned with a severance. There is a formula you solve which your employer agrees to.
The IRS is a lot smarter than you think. Tons of celebrities do just this and get arse raped later on. If you plan to be a consultant and incorporate yourself different story.
The IRS owes my spouse a refund for 6 months, they refuse to acknowledge identity unless call a hotline, that hotline is always busy. While when you OWE the other hotline poof you through. Uncle Sam aint into giving free loans.
If your employer doesn't withhold taxes, you are expected to make quarterly estimated income tax payments to the IRS. If you pay an amount less than the taxes you owe them on your income then they will charge you a late tax payment penalty (unless you have a really good reason for why your income is very unpredictable, in which case you can make an annual instead of quarterly payment). This penalty is about 50bps / month (6% / year).
Even if you expect to make 10% in the S&P (imo a gross overestimate of the current equity risk premium), it would be dumb to pay this penalty, because you can probably borrow at a much smaller interest rate. For example, Interactive brokers currently offers 1.8% margin loans if you are willing to collateralize your existing assets (equivalent or smaller risk than using assets that you owe to the IRS).
Where are you getting 6% annual penalty rate for estimated tax underpayments? https://www.irs.gov/payments/underpayment-of-estimated-tax-by-individua… and https://www.irs.gov/payments/quarterly-interest-rates-for-underpayment-… indicate closer to a 3% penalty (plus interest rate) which is also consistent with my personal experience. The required estimated taxes is also at least somewhat less than the eventual tax bill. https://www.irs.gov/payments/failure-to-pay-penalty is .5% a month but I don't think you would have to pay that if you only had estimated tax underpayments then paid everything by April 15th.
My mistake, short rate + 3% is correct. I've always overpaid but makes me rethink this (+SB), there are times where borrowing at 3% uncollateralized might actually be the best way to get leverage.
Still dumb for the S&P though where you can just use futures.
Federal income tax withholding on supplemental wages is generally 22%, to be specific (or the top marginal rate on amounts over 1,000,000). New York has required withholding on supplemental payments as well.
If you wanted to do something like this, the more practical way is to lower your withholding on your regular paycheck. Most employers should let you do that if they receive a W-4 calculating lower required withholding, but you sign that under penalty of perjury.
Also, the underpayment penalty and interest aren't huge, but I think a margin loan would have lower rates and better tax treatment, so why not do that?
Not smart given your argument is predicated on several things going your way, largest being that the S&P actually goes up. Why not manage your risk better and withhold some and then invest the rest - why does it have to be an "all in" type of scenario? When it comes to personal finances, don't set yourself up for being in a position of any kind of liability, no matter how unlikely you think something is.
So I see where you're coming from but what you're saying only works in theory in a very narrowly paved out scenario. Be smart and manage your risk with a healthy level of conservatism, especially early on. Maybe consult an advisor to see if they can offer an good tax-efficient strategies.
I personally withhold the estimated tax amount in full and dump the rest into various baskets of investments whether they are private, equities, credit, or whatever. And if I ended up paying more tax than needed I'll get a refund I'm owed. As someone above mentioned, if you get tangled with the IRS for money they owe you it can be difficult to navigate. But if they find that you owe them money they will come down on you with the force of god with letter and threats of owing fines / collections of funds real quick.
..
Cum tempora amet voluptatem dolorum tenetur ut. Minima recusandae eaque cumque. Modi aut impedit aut quae quo nam. Sed qui cumque dolorum quia.
Nostrum autem natus nulla sit aliquid ea aut est. Dolore qui quisquam impedit. Officia accusamus illo minima debitis tenetur. Distinctio reiciendis odio et alias.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...