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Tax Planning Services for High-Earning Executives: How to Avoid Surprises Next Year

Being a corporate executive comes with complex compensation plans. Restricted stock units, stock options, and other compensation may be offered in addition to a salary. Therefore, when it comes to individual tax preparation, these monetary benefits can result in a sizable tax bill, particularly for executives who earn enough to land in the highest federal tax bracket.

When a CEO exercises a large number of company stock options, the taxable income generated is often realized all at once. If the tax withholding is insufficient, large option exercises frequently result in large tax surprises.

It is never too early to take action and start tax planning. Now that we are well into 2021, the following are three steps executives can take right now to avoid unpleasant surprises on their 2021 tax returns:

1.    Perform a Paycheck Checkup

Request a mid-year tax projection from your accountant to ensure that the taxes withheld from every paycheck are correct. Due to the pandemic, many executives saw their pay cut or received a smaller bonus in 2020. According to a survey of 984 professionals polled in late 2020, roughly one-third of full-time workers reported a pay cut due to COVID-19.

If those payments are restored in 2021, the amount of tax withheld may need to be increased as well. The IRS has a withholding calculator tool for adjusting the regular withdrawal amount.

If you need to make a change, fill out Form W-4, which tells your employer how much money they should deduct from your paycheck. At the state level, most states have a similar form for adjusting withholding. The withholding formula considers your marital status, the number of children you have, and income sources, along with other factors.

2.    Make a Safe Harbor Payment

To avoid penalties for underpayment of taxes, anyone unsure of their tax liability can also make a “safe harbor” tax payment. It means that you can avoid penalties if you have paid at least 90% of your actual current year tax, or 100% -110% of prior year taxes, depending on income.

Even if you do not know how much your income will be in 2021, you can make safe harbor payments to avoid an underpayment penalty. For example, if your 2020 federal income tax liability was $100,000, and in 2021, you expect higher income, but are unsure how it will impact your total 2021 tax bill, as long as you pay a total of $110,000, which is 110% of your 2020 federal tax liability, via withholding and estimated tax payments during 2021, you will avoid underpayment tax penalties. If it turns out that your 2021 tax bill is $150,000, you will still owe the $40,000 shortfall, but the $110,000 safe harbor payment would protect you from any underpayment penalties.

3.    Understand How Equity Awards are Taxed

Executives who have been vesting Restricted Stock Units (RSUs), Performance Share Units (PSUs), and other equity awards may find taxes withheld from these awards to be lower than expected. The same applies to executives who exercise their stock options. As a result, you may end up owing thousands of extra dollars at tax time.

Many times, executives receive more company equity awards as part of their compensation package. While their regular income tax withholding may be correct, the default withholding tax on vesting stock awards may be lower than anticipated. Unfortunately, some companies do not adjust the withholding for equity awards.

For instance, if you fall in the 35% marginal tax bracket based on your total projected annual income, and your vesting PSU resulted in $40,000 of taxable income, but only 20% was withheld from the award, then you are underpaid by $6,000. To avoid underpayment penalties, you must proactively make a $6,000 estimated tax payment directly to the IRS before the end of the tax year to make up for the shortfall.

The Bottom Line: Plan Ahead with Windes to Avoid Surprises

The compensation structure for top talent is becoming increasingly complex. Investing time now to plan ahead to safeguard your finances could pay dividends next year. You should also be aware of the proposals in Biden’s Tax Plan and you may be impacted.

The best approach is to work with experienced tax and wealth advisors at Windes. Our accountants will help you avoid surprises and find new possibilities to minimize your tax liability and help you achieve your wealth-building objectives. Connect with us today to learn more about our tax planning services.
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