Tax Mistakes That Can Cost High Earners Thousands Every Year

Speaker 1 – 00:00
I’ve been a financial Advisor for over 16 years now, and so taxes are always a core issue of financial planning. The
most common scenarios that we see derive from tax surprises.
Speaker 2 – 00:10
This isn’t any kind of mistake that the client or taxpayer is making. It’s just how the code is written. There’s nothing
they can do about it. You have to plan for it. Most people, when they get that bonus, they’re not looking at pay
stubs. They don’t know what came out for taxes.
Speaker 1 – 00:23
But you have to, if it’s a million bucks, break it down to three categories. What am I going to spend, what am I going
to pay taxes, and what am I going to save? We’ve seen a lot of tax prizes if not planned for properly when it comes
to RSUs.
Speaker 2 – 00:34
So the value of the stock that you’re getting, even though you have ownership of it, you don’t see it in your bank
account, when you take ownership of that gets treated as taxable compensation to you.
Speaker 1 – 00:44
We see executives, it’s typically maybe a 30, up to a 50% or higher of their compensation is stock based, which is
great, but a cash flow issue, we’ve seen it kill really hard.
Speaker 2 – 00:53
The W4 is one of the most irritating tax forms out there. They’re, they’re complex.
Speaker 1 – 00:58
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What we try to do with these clients is anticipate that, get a high level and then withhold a little bit extra out of the
paycheck so that way they’re not having to do any extra work. I think that’s so important is not handing homework
out to clients. I’m like, oh, remember to do this check at this time when we can just take care of it and automate it.
Welcome, everybody. Excited to be joined by our two smartest EWA team members on our tax team up in Erie or
down in Pittsburgh. Today we’re recording this right after tax season two at ewa. How do you guys feel?
Speaker 2 – 01:27
Glad it’s over, Feel accomplished. There’s always rough spots in tax season. They’re unavoidable, but I think it’s
going as smooth as possible.
Speaker 1 – 01:35
You happy and help this year?
Speaker 2 – 01:36
Very much so.
Speaker 1 – 01:38
Thanks, Nick.
Speaker 2 – 01:38
This guy over here saved my life. So.
Speaker 1 – 01:40
And Corey. That’s awesome. Yeah. So after reflecting on tax season, so obviously, you know, I’ve been a financial
Advisor for over 16 years now, and so taxes are always at core issue of financial planning. And so as we try to get
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the smoothest tax experience possible, we always reflect back on what are tax surprises. When are people
surprised, oh, I owe this tax Bill, and then how can communication be effortless moving forward to make sure that
there’s no surprises moving forward? So I would say this year the majority of stuff, you know, was pretty spot on.
But the most common scenarios that we see derived from tax surprises. Nick, what would you say those would be
just the most common thing for high income earner? Maybe a doctor?
Speaker 3 – 02:24
For sure. It’s definitely bonuses. Big bonuses are typically withheld at 22%. If you’re a doctor, you know you’re
making close to a million bucks. You’re probably in the 32 or 35% tax bracket, maybe even the 37% tax bracket
right there. That’s a 13 to 15% delta. So if you’re not kind of communicating with your cpa, with your advisor, you’re
going to get hit with some bad news come March, April, because that adds up pretty quickly too.
Speaker 1 – 02:47
Let’s use an example. Let’s say it’s a surgeon base is 600 grand, gets a huge RVU bonus of 400 grand. The hospital
withholds that at a, typically it’s at your 22% rate. Obviously. Married, fine. Jointly or single, anything above a
certain level is taxed at 37. So that’s a 15% Delta there. Yeah, 400 grand, that’s $60,000 right there. If there’s not
communication of, hey, send us your pay stub when you get that bonus.
Speaker 3 – 03:13
Right.
Speaker 1 – 03:15
That’s we’re $60,000 behind. Right. And if that happens in early in the year, interest is added.
Speaker 3 – 03:21
Yeah.
Speaker 1 – 03:21
What’s the interest rate right now?
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Speaker 2 – 03:22
Around 6.
Speaker 1 – 03:24
Yeah, 6%. That happened midway through the year. 6% Of 60,000 adds up 3,600 times. Half would be $1,800 of
interest penalty as well. So yeah, that’s the most simple ones. And you, when you get those bonuses, you gotta,
you know, we gotta send an estimated payment. A cool way to do that is we’ll typically recommend if you’re big on
travel or credit card points, you can, I believe you do up to three payments under your Social Security number per
quarter as an estimated payment. So you could spread that 60 grand across three credit cards, pay about a 2% fee,
but then earn some big sign on bonuses and net of the fees. Probably save 10 to 20 grand in first class
international travel. That’s a cool strategy that we typically recommend. Is that it for physicians or anything else?
Speaker 2 – 04:03
That’s everyone. Just to take a step back, this isn’t any kind of mistake that the client or taxpayer is making. It’s just
how the Code is written. So all W2 employees basically have two buckets of compensation. You have your
standard base salary, and the withholding on that is all calculated based on the W4 that you fill out with your
employer when you start there. Everything is usually pretty good there, unless you make some pretty bad mistakes
filling that out. But what the other bucket is they call this supplemental income. So that, yeah, that includes
bonuses, whether quarterly, annually. That includes stock options, basically anything in addition to your standard
base pay. And how the IRS withholding rules are written is you can withhold on that supplemental pay based on an
aggregate method, which essentially no employers do.
Speaker 2 – 04:53
But then there’s this flat percentage method, which is what everyone does. So it’s nothing that the taxpayer, that no
mistake they’re making, there’s nothing they can do about it. It’s just, you have to plan for it. What we talked about,
most are withheld at 22%. So you just have to be aware. Most people, when they get that bonus, great, hey, got
extra money? They’re not looking at pay stubs. They don’t know what came out for taxes. But you have to, when
you get that additional compensation, you have to be aware, hey, I should probably let my tax person know that this
came in because most of our, most of the high earners, you’re looking at, you know, high five figures, even six
figure, you know, supplemental pace. And so that, like we already discussed, that’s a huge gap in the rates, no
doubt.
Speaker 1 – 05:37
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Yeah. So I would say, you know, just some best practices. So if you’re making a million dollars a year and you’re
married, and this is just general, there’s like, obviously if you take a standard deduction or if you do, you know,
itemize, it’s going to be different. But in general, you’re going to pay federal taxes. 10, 12, 22, 24, 32, 35, 37. But if
you blend that all together, and if you’re making a million and just do standard deduction, you’re going to pay about
28% at a blended rate. So 280,000 in federal tax. If you live in Pennsylvania, you pay about 30,700 in Pennsylvania
tax and then 10,000 in local tax. Unless you’re in downtown Pittsburgh, it’ll be $30,000.
Speaker 1 – 06:10
So in general, if you’re married, filing jointly in Pennsylvania, you’re going to pay about a.32% of your money is
going to go 32.1% is going to go right to taxes. So now in the age of AI, I always like to look at recommend clients.
You know, just look at, okay, here’s my expected income between base and bonus. If it’s a million bucks, break it
down to three categories. What am I going to spend, what am I going to pay taxes and what am I going to save.
And generally speaking, if you can do a third and a third, at that high of the level of income, you’re in great shape. If
you can do keep the taxes under 35, keep the spending under 40 and save 25, you’re still in decent shape. Not like
super accelerated financial independence.
Speaker 1 – 06:47
But I do think it’s really healthy to look at where all the dollars are going because in the reality, if you do an exercise
like that once a year, you kind of call shotgun on the intention of your money. If you just kind of take it day by day,
when you get that bonus, you’re stressed out. You’re like, oh, we can do that backyard project with the new kitchen
that the spouse wants. Or, you know, and so then the money goes quickly, the money temperature goes up. And
then not only do we not save, but now we’re figuring out where do we pay this $60,000 or tax at the end of the year.
And that’s where there could be some real big stress as well. Just real quick, if we take that, obviously it’s better to
be married.
Speaker 1 – 07:21
From a tax perspective, typically if the single person making a million, the same example, you would pay 32%
blended rate federal because the brackets get compressed and so you’d end up paying all in about 36% versus 32,
so about $40,000 more in tax. So you have to be extra careful if you’re not married and single and get those
bonuses because then it’s more of a higher rate, subject to quicker as well. Let’s shift to rsu. So this is more for our
corporate clients. Executives in training, key employees at publicly traded companies, they get this rsu. So talk
about the mechanics of how this works. So, and just real quick, from a financial planning perspective, if you’re
getting an rsu, that means you’re doing a great job, that the employer that you have really wants you to be there.
Speaker 1 – 08:04
Typically their issue, they’re, they best, you know, maybe graded over three years. It’s a way to keep you there and
always have a hook into you. If you leave, there’s going to be unvested money on the table. So it’s a really good
retention program. But from the tax perspective, they can be pretty surprising. And so we’ve seen a lot of tax
surprises if not planned for properly when it comes to RSU’s, you know, either vesting if you didn’t do an A3 meal
action. So Ty, do you want to give us just a high level of how they, how the taxes work and where people have
tripped up?
Speaker 2 – 08:35
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They can create a pretty big surprise because you’re not getting any cash in your pocket like a typical bonus would
be. So when you get these stocks that the company give to you and they vest and when you receive those stocks,
it’s treated exactly like a bonus. So the value of the stock that you’re getting, even though you have ownership of it,
you don’t see it in your bank account. So when you take ownership of that, it gets treated as taxable compensation
to you. So it goes back the same type of thing again. That falls in that bucket of supplemental income. And when
you get that, they withhold on that at a lower rate as well. That can be a big surprise where. Well, okay, got this
stock. What do I do with it now? It’s going to be in my W2.
Speaker 2 – 09:26
They withheld taxes on it. Yes, but the value of that can get hit at your ordinary rates and they’re only taking out a
lower rate,.
Speaker 1 – 09:35
The 22 or the. Yeah, and I think RSUs are often withheld at 24. I’ve seen. Right. Or is it a flat. It depends on the HR
system that these use. But okay, so specific example. So someone at a publicly traded company, Google, Amazon,
doesn’t they get a hundred thousand dollars worth of RSUs this year. That employee has two invest in three years.
That employee has two choices. They can do an A3B election and take the 100,000, realize it as ordinary income
and then let’s say they sell it later for 200,000. They paid the tax. Let’s say they’re under 37% tax bracket in federal.
That’s federal only. We’ll talk about today. They paid the 37 grand. It grows to 200.
Speaker 1 – 10:11
Then they don’t have to pay the 23.8% tax on the capital gain versus if they didn’t do the 83B election, then they
have to pay all 37 on all 200 when at best that year. But the downside of the 83B is if they get fired or leave before
it gets vested, they just pay tax on something that they’ll never actually get. They can’t get that.
Speaker 2 – 10:30
And you also have to come up with the cash to pay it up front.
Speaker 1 – 10:33
Up front, yeah.
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Speaker 2 – 10:34
So, yeah, again, if you elect to pay tax on that $100,000 we use, come up with the cash to do it, something
happens. Company tanks, you’re out at that tax.
Speaker 1 – 10:45
Or the stock price could drop. And then you’re like, well, I just paid tax and somewhere it’s worthless, so. Or you
know, it’s going down in value. Yeah. So just to replay that, most of the time we don’t see 83B elections. You know,
you just let it ride. And then let’s say the 100 vest in three years is now worth 200. The HR system withholds at a
24% tax bracket, $48,000 gets withheld. So you actually get 152 of stock deposit in your account. At that point, you
could sell it that day and go buy something or you could diversify it with other stocks. At that point, that 152 that
would be left starts a capital gain. Anything above that, if you let it ride for a year and one day, then you could get
capital gains on anything above that.
Speaker 1 – 11:21
If you sell it right away, your basis is the same as what the value is. So you can just rip it with no tax. You’ve already
paid. But the reality is on that 200, they’ve taken 48 out of for tax, but you owe 74.
Speaker 3 – 11:32
Right. Right.
Speaker 1 – 11:33
So that’s a $26,000 Delta right there. And that’s just simple example what Matt when he said, I got $100,000 RSU’s.
It doesn’t matter. It’s one vest. What’s the fair market value that they invest and you have to owe ordinary income
tax. Just that example. That’s a $26,000. We’re behind.
Speaker 3 – 11:50
Yeah. And you don’t get cash. Your cash flow is all of a sudden hurt now too. Unless you do sell it.
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Speaker 2 – 11:55
Sell it.
Speaker 1 – 11:56
And then what I’ve seen really hurt is if you’re an executive that has a blackout period and it looks politically looked
at poorly if you sell your stock.
Speaker 2 – 12:04
Right.
Speaker 1 – 12:06
Because now it’s like you have to come up with that out of pocket if you’re not comfortable selling your stock.
Yeah. And so we see executives, it’s typically maybe a 30, up to a 50% or higher of their compensation is stock
based. Which is great. I mean, it’s because I think it aligns the company with the, you know, stockholders,
shareholder value, etc. But from a cash flow issue, we’ve seen it kill really hard. It makes it really hard to manage.
Speaker 2 – 12:30
But it does also go back to planning because if you get that issued earlier in the year, say May, you have until next
April to pay the tax. So it’s way better to work into your budget. Okay. Over the next 8, 9, 10 months. How do we eat
into this versus okay, let’s file a return April 10th and we have this huge cash outlay that we have to worry about.
Speaker 1 – 12:51
Okay. Let’s talk about any other low hanging fruit. Like what if both spouses are working? Because you have to
have, like if one spouse works here. One’s a hospital, one’s an executive. Those two companies certainly aren’t
going to care about each other.
Speaker 3 – 13:06
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Right.
Speaker 1 – 13:06
So it’s the spouse’s job to work with the team to look at withholding. So how often have you guys seen this come
into play when it comes to.
Speaker 2 – 13:13
I think, I think it’s super important, actually. Very big project we’re working on now that the filing season is over is. I
think everyone should just take a step back and review W4. So I think Nick would agree. The W4 is one of the most
irritating tax forms out there. They’re, they’re complex. What, what boxes do I check? Well, I got dependents, but
should I fill it out now?
Speaker 3 – 13:35
There’s a table now. Yeah.
Speaker 2 – 13:37
There’s additional tables that you have to like. The font’s really small and you know, you can have extra withholding,
but most taxpayers will get that and they’ll fill it out just like it reads. So say you have a married couple. Both of
them make four or five hundred thousand dollars. They’ll check that they’re married, filing jointly. The, the spouse’s
employer doesn’t know what the other spouse makes. Right. So they’re just kind of assuming that the money that
individual responsible is for the entire household. When, when in reality you have another, you know, huge salary
there. So they’re not withholding at the correct rate. So there’s ways around it. A lot of it is trial and error.
Speaker 1 – 14:14
500. That could be an easy 10 or $15,000. Swinging.
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Speaker 2 – 14:17
Yeah.
Speaker 1 – 14:17
If they’re expressing the rates like that. Right. That’s. Yeah.
Speaker 3 – 14:20
And you multiply by two kind of.
Speaker 1 – 14:22
Yeah.
Speaker 3 – 14:22
Then if the spouse is.
Speaker 1 – 14:23
Doing the same thing, that’s super important. And then I think especially we’ve worked with a lot of doctors, they’re
make maybe making half a million or a million, whatever it is. And then they have this little side income like
medical malpractice witness we see very common. Or maybe they’re consulting for a pharma company. That’s 50
grand a year. Well, that’s 1099. So you have not to pay your Fed, you have to pay, you know, double Medicare tax on
that. You know, so that could be another 40 to 50% that’s going to go to taxes. So a lot of times, if that’s consistent,
when we do those W4 audits would go in and we withhold extra. We’ll just anticipate that extra income and
withhold extra. So that way. Because annoying things, if you’re a busy doctor executive, you don’t want to like in
Pennsylvania.
Speaker 1 – 15:05
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I think the worst thing in the world is before I work with Utah or I would say you have to pay $200 to local every
quarter and 500 to state and then like whatever to federal. And I’m like, so I have to write three checks four times a
year, I have to write 12. Like that’s not an efficient use of my time. So now what we try to do with these clients is
anticipate that get a high level and then withhold a little bit extra out of the paycheck so that way they’re not having
to do any extra work. The local and state are so small, we’re fine just, you know, accepting a little bit of an interest
penalty, just covering it in one check and then the year once we know what it is.
Speaker 2 – 15:37
But also much easier too because it’s a flat rate, it’s not blended. So yeah, it’s much easier to.
Speaker 1 – 15:41
Easier that, yeah, I think that’s so important is not handing homework out to clients. I’m like, oh, remember to do
this check at this time when we could just take care of it and automate it.
Speaker 3 – 15:52
I try to push automatic payments as much as I can, or even handling it for them, going on direct pay and making
the payment for them, it’s just quicker, it’s easier. They don’t have to worry about it. It’s part of our service.
Speaker 2 – 16:02
We have record of it.
Speaker 1 – 16:03
Yeah, we have the poa. So we can. The power attorneys. We can do that. That’s awesome. All right, so isos, these
are get tricky with amt, right. So Nick, what’s talk about less common with you know, in the like physician world.
But this would be more in like a lot of tech employees, software engineers or executives. We, yeah, we would see
those. But how’s the tax surprise come from ISOs?
Speaker 3 – 16:27
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Basically whenever you exercise your ISO, you’re paying basically discounted rate compared to the market value.
So that difference gets multiplied by the amount of shares you actually are exercising at that time. And that’s, that
creates what’s called an AMT adjustment, an alternative minimum tax adjustment. And those numbers can get to
be pretty big. I mean, we’ve seen couple hundred thousand dollars tax adjustments and AMT is kind of ugly. It can
add up pretty quickly. I think we had a scenario where what was the total amt? A hundred.
Speaker 2 – 16:55
Yeah. Over a hundred thousand. Yeah. Because the growth of the stock had been so substantial over the last few
years. It was, yeah, the, the AMT income was substantial.
Speaker 1 – 17:06
This is something that needs an extra look, correct?
Speaker 3 – 17:08
Really?
Speaker 2 – 17:09
Da.
Speaker 1 – 17:09
Yeah.
Speaker 3 – 17:09
So if you have stock options that are ISO and you know the ISO, that definitely needs a CPAS input because. And
that’s hidden. I mean, you don’t know. It’s not withheld. You know what I mean? It’s just extra tax that gets tacked
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on your tax return. No doubt. So that can really create some headache come, you know, tax filing time.
Speaker 2 – 17:26
What the IRS is doing is saying, okay, well you bought the stock at this really low rate, but it’s really worth this
much. So we’re going to collect our tax on that paper gain that you had by getting it.
Speaker 1 – 17:38
So Tyler, I see it with our Pennsylvania Pittsburgh clients. You know, Pennsylvania for like a business owner that
has lots of deductions. You know, maybe they have a business owner Is, gets their AGI. They’re like 2 million. They
get their AGI down to like 1 1/2 because they have all these deductions. And then they’re like, oh, Pennsylvania,
3.7% of the one and a half. But then the big surprise is, well, no, Pennsylvania doesn’t recognize some of those
deductions. So, so talk to us just like an 8020 analysis. Like what are three common things that you see that
people think, oh, I only have to pay 3% on the one and a half when they really have to pay a higher amount. So what
are those some of those basic high level adjustments that people should be aware of.
Speaker 2 – 18:17
Pennsylvania is kind of a tricky state. So a lot of states will start actually at federal AGI or federal taxable income.
When you’re calculating state tax, Pennsylvania does not. They look at everything separately. So all income
buckets, wages, business income, capital gains losses, interest and dividends. And one kind of, I guess, funny
thing about Pennsylvania is they don’t recognize losses. So on uncertain buckets. So if you have wages, interest,
income, dividends, but then you have a capital loss, they don’t recognize that. They’re just adding up the income
items, so that’s one thing. Also, Pennsylvania does not recognize itemized deductions. So state and local taxes,
mortgage interest, charitable donations, there’s no deductions for that at the state level. So even though you might
be getting 70, 80, $100,000 deduction at the federal level, there’s nothing at Pennsylvania.
Speaker 2 – 19:15
So you just can’t use your federal AGI to calculate Pennsylvania tax.
Speaker 1 – 19:19
So someone could like realistically have a $2 million Pennsylvania income and a one and a half million dollars
federal.
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Speaker 2 – 19:24
Sure. Yeah. Very common. Yeah. And one other big, I guess, decoupling item for Pennsylvania is they don’t
recognize bonus depreciation. You buy a vehicle, you buy equipment.
Speaker 1 – 19:37
That could be nice, clean.
Speaker 2 – 19:39
Yeah.
Speaker 1 – 19:40
There could be some huge differences.
Speaker 2 – 19:42
Yeah, you get that six figure deduction at the federal level. Pennsylvania doesn’t allow it. You have to basically
straight line it. So those are big and it’s all at 3%. So those are some pretty big items.
Speaker 1 – 19:54
Where you guys need to get a plan. The drive from here in Pittsburgh is kind of brutal.
Speaker 2 – 19:58
Cops are long.
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Speaker 1 – 19:59
What is that, two hours?
Speaker 3 – 20:00
A whole two hours, man. It’s a long drive.
Speaker 2 – 20:02
We just get a copter. Is there spot on the roof to land it?
Speaker 1 – 20:05
I feel like that’s, ever since Kobe went down. IP a little afraid of the copters? No, Maybe someday. Not. Not in the
budget right now. All right, so anything else? I think we covered the majority, like 90% of what we’ve seen happens
from a business owner perspective, it’s completely different. We’re going to do a whole other podcast on that. But
anything else from like a W2 bonus stock, anything else you guys see or do you think that those are the biggest
one where just communication as income changes as bonuses come as RSU’s best is crucial?
Speaker 2 – 20:35
Yeah, I think those are the biggest ones I think we saw. That’s where all the surprises and then.
Speaker 1 – 20:39
Ongoing calibration of the W4s and realizing your two employers aren’t talking to each other, that’s your
responsibility and our responsibility to help you to make sure everything is talking together. The financial plan
takes all the pieces that don’t communicate and you know, one rat will make it cohesive and effortless, hopefully.
Speaker 2 – 20:57
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So.
Speaker 1 – 20:57
All right, everybody, thanks for joining us. We’ll catch you next week.