Large paychecks (RSUs) and taxes

Question

A third of my yearly income comes in two paychecks in the second and fourth quarters of the year. The federal tax on these two paychecks more than adequately covers my total tax. Even if I don't pay federal tax on my regular monthly paychecks, my tax return is an equivalent of a whole paycheck.

These two paychecks are RSUs, reported as regular wages on my W‑2. Apparently either the W‑4 doesn't cover them or there is a (large) minimum percent withheld.

I am concerned that if I set my W‑4 to withhold no taxes I will owe a penalty for not paying any taxes in the first and third quarters.

What is the minimum tax I need to pay in the first and third quarters to avoid this penalty? And if the sum of the taxes in the first and second quarters covers the third, do I still need to pay a minimum amount?

I assume the IRS has an exorbitant interest rate, so investing the amount does not bring me out ahead.

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Update #2 (to state the question more explicitly)

Can I withhold $0 on my regular paychecks without being penalized by the IRS? What if I don't have a job anymore in the second half of the year? (I don't anticipate losing my job, but want to be prepared for it nonetheless.)

The question is not about how to reduce (or increase) the withholding on the RSUs, I've called the broker, they won't or can't do it. Some of the answers and comments talk to this. While useful information, it is not the question.

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Update #1 I already have my W‑4 with 25 allowances and withhold an "additional" amount for each paycheck. The 25 allowances ensures only the flat amount comes out of each paycheck, with the exception of the RSUs.

I think my RSUs are not counted as supplemental income because I do not see it as such on a W-2. They are included in my regular wages on my W‑2. On the other hand, they do take a 25% cut from the RSUs and withhold it for taxes. This seems normal for RSUs from my searching around the internet; so I consider them as regular wages and not supplemental income. I'll be reading Pub 525 very carefully now. (Update: Pub 525 doesn't say they are supplemental income. So my question still stands.)

Answer 1

W4 only affects regular paychecks. RSU's, bonuses, and other irregular payments are subject to flat 25% withholding (unless, in certain conditions, the employer chooses to calculate W4-rate withholding. Most don't).

You misunderstood the "supplemental income" thing. RSU's, bonuses, ect - these are wages. But they're not regular payroll. Withholding only affects regular payroll. See the IRS publication 15 (known as Circular E), the guidelines on withholding for employers:

Supplemental wages are wage payments to an employee that are not regular wages.

If your marginal rate is more than 25% you may end up with underpayment at the end of the year, if you don't account for that correctly. You don't need to pay estimates, you just need to adjust your W4 so that the total withheld (including the 25% withheld from the RSUs) will be close to the needed amounts. You can change your W4 any time during the year.

And I left out the most important thing for you... If you pay your taxes through the salary withholding (i.e.: through your W2) - you don't need to worry about the estimates and penalties. As long as you pay throughout the year enough to cover your liability, if it came from W2 - it doesn't matter when it was withheld.

Note, that if you have less than $1000 due because of withholding (and not estimates!) - you don't owe any penalty. See the IRS pub. 505 and the IRC Sec. 6654(g).

Answer 2

Disclaimer: This entire post is my interpretation of the tax code, and you would do well to get a second opinion from a tax professional, or perhaps reaching out to an IRS representative.

Per [Publication 505 p.23], you are only obligated to pay estimated taxes (quarterly payments) if you expect to owe more than $1,000 for the calendar year (when you file your taxes next year). Thus, you are only subject to such underpayment penalty if you are also obligated to pay quarterly estimated taxes.

My understanding of your situation is that your Q2 and Q4 RSU checks cause enough taxes to be withheld that you would still get a (sizable) filed return even if you paid $0 in taxes for your regular paychecks, so you should be fine doing so.

The quarterly underpayment penalty was designed to prevent people from making a single large payment near the end of the year (or the beginning of the following year). This does not apply to people who have their taxes withheld by an employer, but to (mostly self-employed) people who initially receive their income tax-free and have to pay taxes on it separately.

Answer 3

I will try not to repeat the good points mentioned in earlier answers and instead attempt to answer purely by referencing the various weird withholding techniques I've used in the past, none of which resulted in any contact from the IRS whatsoever.

1. In graduate school the default withholding that my employer (university) took from my paychecks totalled to significantly more per year than I owed. Since I earned below the poverty line, this deferred pay was unacceptable. I consulted Payroll and asked how many Withholding Allowances I would need to write on my W-4 to achieve withholding of X per paycheck, where X totaled to slightly less per year than I owed. For a couple years I just used that number (4 or 5 or something) and everything was groovy. No complaints from the IRS (and why should there be, since I was still "paying as I went").

2. Later in graduate school I learned I would incur capital gains that would approximately double my income one year. Since I could not withhold from the capital gains, I needed to increase my employer withholding to cover that extra tax. Since some of the checks left in the calendar year were for reduced-pay periods (yay, grad school), my standard withholding would vary on each check. Rather than try to account for those variances, I simply set my Withholding Allowances to 10 (which resulted in about $5 withheld per month) and then set my Additional Amount to Y, where Y was my (new) anticipated total tax for the year, minus the amount I'd already withheld, divided by the number of paychecks left in the year. Payroll infomed me that they would "have to notify the IRS" if I submitted a W-4 with >= 10 claimed allowances. So I did, and they did, and I never heard anything about it. I liked the results so much that I left my W-4 that way for the rest of school. (Still "paying as I went".)

3. In the corporate world (more money involved) I stuck with the same approach. I pre-calculated the amount of tax I would owe for the year (including on my RSU awards), subtracted the mandatory 25% that would be withheld from those awards, divided by 24 paychecks, claimed 10 allowances, and withheld an additional Z dollars so as to come in a little below what I would owe. This is sort of the opposite of your situation; the awards were significant but not nearly so large that the mandatory withholding on those awards could by themselves pay my entire tax bill for the year. (Also, my company did not allow me to withhold a larger-than-mandatory percent of the RSU awards, so I could not engineer a withhold-only-on-the-RSUs solution even if it had occurred to me to do so.) Again, never heard anything from the IRS for 5 years. (Still "paying as I went".)

4. Much later in the corporate world, where my supplemental wages far far exceeded my normal wages, I finally stopped "paying as I went". I went back to a plain vanilla W-4 (no overclaiming allowances or adding additional withholding), but now the mandatory withholding on my bonuses came to far less than I owed per year. Even if I withheld 100% of every regular paycheck, I would still not have been withholding enough to avoid an underpayment penalty at the end of the year! Fortunately, my employer now allowed me to withhold additional amounts on my bonuses. To maximize the money in my pocket, then, I withheld the minimum on my first n-1 bonus payments for the year, and then instructed Payroll to withhold practically the entire amount of my nth bonus payment in order to cover my tax bill for the year. I was definitely no longer "paying as I went", but the only thing that apparently mattered was that on my W-2 at the end of the year the total withholding was very close to the actual amount I owed that year. Again, never heard anything from the IRS for many years.

It sounds to me like you're in a situation similar to my (4) above. I certainly could have kept up my W-4 trick in that scenario and essentially withheld nothing from my regular wages and a whole mess from my final big bonus payment. The reason I did not do so was that, despite all my experience messing with my W-4 in previous jobs,

(a) it wasn't really worth the hassle. The size of each regular wage payment was so vanishingly small compared to my supplemental wage payments that the tax on each regular wage payment was even more vanishingly small.

(b) the chances of the IRS auditing your taxes are tiny when you make very little money and enormous when you make lots of money. So even though they'd never said anything to me before, why risk having any extra weirdness in my records?