Author Topic: Need some help reducing taxes  (Read 326 times)

pseudoyams

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Need some help reducing taxes
« on: July 09, 2018, 10:05:32 AM »
Hey everyone!
  Id like to consult with the MMM powers out here on how I can further reduce my taxes. I think I'm going down the right direction, but would like any input.

My income is split between base salary and commission.  The thing that gets me is that the monthly commission pay is considered bonus pay and is taxed much higher @ 38-40% vs 22-24% for base salary. TBH, Im not exactly sure which bracket we'll fall into this year.  I've been at my current position since the turn of the year.  From what I hear others just accept it and get a large tax refund the following April.  Id like to avoid that. We easily live off my base salary and so the commission/bonus is truly that for us.  The amount varies but it goes right into the bank account(s) for now. Just for reference, target commission is about $40k / year.

Currently, I max out 401k and HSA from my base salary.  I also contribute pre-tax about $1500 / year into a Dependent Child Care Account (DCA - my two kids are almost in school full time now. ;) )  I also max out my Roth and contribute to the kids 529 plans but only to the tune of about $1450 / year. As I understand 529 contributions will help with local state taxes (I'm in WI).

So Im running through this and I believe the ideal solution would be to change my HSA and 401k deductions to only my commission pay to the tune of $445 per month for the HSA, then 100% remainder into the 401k until fully funded.  This will max out both accounts after employer matches and such.  This should save about 16-18% taxes from my calculations.

This will leave the pre-tax contributions for the DCA in my base salary and post-tax contributions for Roth and 529 from base salary as well.

My company also offers ESPP which I put a few points towards from total comp (base and comm.) - I realize this might be something to consider outside of this discussion but i thought Id mention.

Is there anything else I can do to reduce the tax burden further?  What can I do with the remainder for the commission/bonus pay after 401k and HSA is fully funded to avoid the high taxes on it?

Id appreciate any advice on this.

Thanks!

terran

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Re: Need some help reducing taxes
« Reply #1 on: July 09, 2018, 10:57:14 AM »
My income is split between base salary and commission.  The thing that gets me is that the monthly commission pay is considered bonus pay and is taxed much higher @ 38-40% vs 22-24% for base salary.

Just to be clear, there is no such thing as a separate bonus pay tax bracket, so you're not being taxed more on bonus pay, more is being withheld from your bonus pay. This happens because the withholding formulas are designed to assume you make the same amount of income every pay period. If you did make the amount you make in a bonus pay period every pay period then the higher withholding would likely work out. As it is, you'll likely get a larger refund than normal given the faulty assumption of the withholding formulas.

So are you looking for help reducing your taxes, or are you looking for help making sure your withholding more accurately reflects your taxes?

pseudoyams

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Re: Need some help reducing taxes
« Reply #2 on: July 09, 2018, 11:15:33 AM »
Hmm. Ok, so this is where it gets a little fuzzy for me trying to understand this.

On my normal salary vs commission pay 'Federal Income Tax' (as its labeled) is more than double on the commission pay vs salary even if the gross comm. pay is 75% that of my salary pay.  Is this not actually tax? SS, Medicare, and WI tax are all a bit less in this situation.

Id like to avoid/reduce that with pre-tax deductions and also make sure my Federal and WI exceptions are accurate to even it out so I dont get a large refund every year.  Are those federal/state exemptions the same as withholdings?

Also, just for clarification, I receive two base salary checks (both are exactly the same) and a commission/bonus check on top of that each month.  Commission pay varies.  So, three checks per month, every month.

So, I guess this turned into a two-fold question.

terran

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Re: Need some help reducing taxes
« Reply #3 on: July 09, 2018, 11:31:42 AM »
Right, so the amount you're seeing on your pay stub is the withholding. If you owe more tax than is withheld at the end of the year you'll have to pay, if you owe less than is withheld you'll get money back. You don't want to under withhold because you'll owe penalties, you don't want to over withhold because you could invest that money now if the Treasury wasn't holding onto it "for" you.

How much did you owe in taxes last year (line 63 form 1040)? Do you have an estimate of what your total income will be this year?

pseudoyams

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Re: Need some help reducing taxes
« Reply #4 on: July 09, 2018, 11:52:19 AM »
Line 63 on the 1040 for 2017 is $7,744. I think we had a refund of around $2k-ish.  Paystubs show I have $19k already withheld this year so far.

My income is higher this year, plus the commission portion.  Total comp should be right around $160k or a bit more.

Typically its just been setting the fed/state exemptions for the family and be done with it, but the extra commission tax/withholding is eating at me to level that out or reduce it.  This is my first year having to factor in comm. pay, so I appreciate the help.

seattlecyclone

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Re: Need some help reducing taxes
« Reply #5 on: July 09, 2018, 12:32:34 PM »
It sounds like your bonus-heavy pay is causing you to overwithhold on taxes, as you received a rather big refund last year and you are earning even more bonus this year. As @terran said, tax withholding is not the same as tax owed, but it's to your advantage to keep any overwithholding to a minimum in order to get that money invested and working for you sooner. Bonuses are withheld at a flat 22% for federal income tax, plus any social security and state taxes on top of that. No way to change that base rate. Your idea of moving more of your pre-tax deductions (HSA, 401(k), etc.) from salary to bonus seems like a good one. Another thing to consider is updating your W-4 with more exemptions; this will only apply to your withholding for your base salary paychecks.
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terran

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Re: Need some help reducing taxes
« Reply #6 on: July 09, 2018, 01:12:33 PM »
Since your 2017 AGI must have been under $150k (given the amount of tax you paid), as long as you withhold 100% of your 2017 tax owed you won't owe a penalty. If your AGI were over $150k you would need to withhold at least 110% of the previous years tax. You've already withheld more that that.

Assuming you're married, your spouse doesn't work, you have 2 kids, you max your 401(k), HSA, and put $1500 in your Dependent Child Care Account, on $160k gross income by my math you'll probably owe something like ~$12k this year. You'll be in the 22% marginal tax bracket with about $56k before you hit the 24% bracket. Your tax due could be lower if you pay medical insurance or have other deductions I haven't accounted for, or higher if you have investment income, your spouse works, etc. As long as you withhold at least 90% of this amount you also won't owe penalties, so you're safe under this measure too.

As long as you withhold over either of these safe harbors you won't owe a penalty meaning you've already over withheld so the trick now is getting withholding as low as you can. The only way to do that is to add exemptions to your W4. My guess is HR won't let you add enough to get your withholding to $0 for the rest of the year, so I guess you'd just have to ask what the most they'll let you enter is. I would probably try telling them you've already withheld more than you expect to owe in taxes this year and see what they'll let you do.

It sounds like you're already taking advantage of all the ways to lower your actual taxes due (assuming you're maxing the 401(k) and HSA).

robartsd

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Re: Need some help reducing taxes
« Reply #7 on: July 09, 2018, 02:09:56 PM »
On my normal salary vs commission pay 'Federal Income Tax' (as its labeled) is more than double on the commission pay vs salary even if the gross comm. pay is 75% that of my salary pay.  Is this not actually tax? SS, Medicare, and WI tax are all a bit less in this situation.
SS and Medicare are taxed at fixed percentages. Those won't change until you've reached the annual maximum for SS.

Federal (and usually state - I'm not familiar with WI taxes) income taxes are taxed at higher rates the more you earn. The actual tax isn't computed until you fill out your return, but estimated taxes are withheld from every paycheck. Generally the less consistent the pay, the more the default formulas over withhold. The tax collection agencies like to give guidance that over withholds because 1) people are generally happier filing for a refund than owing taxes and 2) the government gets an interest free loan until you file your return. Some employers seem to withhold the maximum marginal tax rate for all bonuses regardless of what you fill out on your W-4.

pseudoyams

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Re: Need some help reducing taxes
« Reply #8 on: July 09, 2018, 02:14:51 PM »
Ok. This is making sense now. I apologize my ignorance but your all are helping me with a ton of good info!

Yes, my AGI for 2017 was about 65-70% of what I expect it to be this year.  I am married and the wife works a couple days a week. I think she grossed $20k-ish last year and that will stay about the same for this year. 2 young kids - 5 and 7 yo.  2018 AGI should be about $130k after 401k ($18,500), HSA (5,350), DCA (1,500), and medical (3,840).  Employer contributes 1500 / year into HSA so thats why the weird number.

I realized the $19k number that I mentioned before was incorrect, that is all tax withholdings on the stub - federal, state, medicare, and social security.  Federal is $9200 of that so far this year.

It sounds like there's not much else I can do to reduce actual taxes as Ive taken advantage of all pre-tax deductions.  Does it still make sense to move HSA and 401k deductions to strictly commission/bonus pay? 

And, is there a good calculator out there to accurately estimate the exemptions I should claim to minimize tax withholdings?


MDM

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Re: Need some help reducing taxes
« Reply #9 on: July 09, 2018, 02:37:31 PM »
Ok. This is making sense now. I apologize my ignorance but your all are helping me with a ton of good info!

Yes, my AGI for 2017 was about 65-70% of what I expect it to be this year.  I am married and the wife works a couple days a week. I think she grossed $20k-ish last year and that will stay about the same for this year. 2 young kids - 5 and 7 yo.  2018 AGI should be about $130k after 401k ($18,500), HSA (5,350), DCA (1,500), and medical (3,840).  Employer contributes 1500 / year into HSA so thats why the weird number.

I realized the $19k number that I mentioned before was incorrect, that is all tax withholdings on the stub - federal, state, medicare, and social security.  Federal is $9200 of that so far this year.

It sounds like there's not much else I can do to reduce actual taxes as Ive taken advantage of all pre-tax deductions.  Does it still make sense to move HSA and 401k deductions to strictly commission/bonus pay? 

And, is there a good calculator out there to accurately estimate the exemptions I should claim to minimize tax withholdings?
+1 to pretty much everything said so far.  I might be a bit more optimistic on the large W-4 allowance number, should you decide to do that.  Used to be that employers had to notify the IRS when someone wanted to use ~10 or more allowances, but in a spasm of reasonableness the IRS dropped that requirement some time ago.

You could try the IRS Withholding Calculator or the case study spreadsheet.  For either of those, you have to add the amount you expect withheld from future bonus payments to the "amount already withheld" because the W-4 applies only to regular pay.

If you haven't already, see also lines 64, 74 and 75 on last year's https://www.irs.gov/pub/irs-pdf/f1040.pdf.  That may help distinguish withholding from tax due.