tl;dr

• Individuals who earn supplemental income like RSUs and Bonuses may end up with federal taxes under-withheld. This is because the IRS allows companies to withhold income tax on supplemental income at a 22% rate.
• Individuals are responsible to make sure they hit the IRS safe harbor threshold of paying the lesser of 90% of what they owe this year or 110% of what they owed last year
• There are ways to profit or lose money when paying the taxes you owe to the IRS. Here are some examples for a hypothetical E6 Software Engineer (SWE) at Meta making a $254,599 in Base Salary, a $38,283 Bonus, and $348,216 in RSUs a year:
  • We assume the SWE needs to pay $25,202 to meet the safe harbor threshold. Our $0 break even case assumes the SWE adjusts up their paycheck and RSU withholdings to pay the government the extra $25k evenly over the course of the year.
  • Paying estimated taxes with credit cards to earn sign up bonus can net out to $2,665
  • Paying estimated taxes with a credit card earning 3% cash back can net out to $421
  • Investing the money in a 5% money market fund, and using additional paycheck withholdings to hit the safe harbor in November / December can net out to $275
  • Not meeting the safe harbor threshold, investing all the money in the S&P 500, and eating the 8% penalty has huge variance. It can net out to a $5,555 loss or $2,345 profit in the S&P’s worst and best year’s respectively. In the average year for the S&P, it nets out to a $540 loss after accounting for taxes on the gains.
  • Paying 100% of taxes owed, rather than just hitting the 90% safe harbor number, results in a $437 opportunity cost vs keeping the money in a money market until tax day.
  • Paying everything at the full 37% marginal rate, to avoid having to do the math to figure out how much their taxes would be, results in a $4,033 opportunity cost vs investing in something like the S&P. (Please don’t do this.)

Intro

Many tech workers receive Restricted Stock Units (RSUs) as a part of their compensation. Employers are allowed to¹ withhold federal taxes from RSUs, as well as other supplemental income, at a 22% rate². Everyone in this blog’s target audience is subject to a higher federal tax bracket than 22%, with some subject to the highest rate of 37%. The federal government treats RSUs as income, so they want the full 30-something percent they are owed, regardless of the fact that companies only took 22% out to pay them at vest time. If the IRS doesn’t get enough of their money on time (more on what “on time” means later), they charge interest on the amount that was underpaid. Currently, that interest is at 8% for Q2 2024.

The IRS considers that you’ve paid “enough” money if you’ve met the lesser of either of these two safe harbor requirements:

• You paid 90% of what you owe this year
• You paid 110%³ of what you owed last year

Note that there is a small gotcha here: These numbers include taxes you owe from non-wage sources like dividends, interest, and cap gains. So make sure you factor those in when doing your math!

How you get to that “enough” number can be costly or profitable.

It should go without saying, but I’m just some random dude on the internet that isn’t an accountant (and more importantly isn’t your  accountant). I’ve done my best to cite reliable sources, and to include my own experience, but make sure to do your own research and understand the consequences of what you’re doing before blindly following anything in this post.

Scenario: IC6 SWE at Meta

For the rest of this article, we’ll work with the following numbers for an E6 Software Engineer (SWE) at Meta, from levels.fyi:

• Base Salary: $254,599
• Bonus: $38,283
• RSUs: $348,216

This adds up to a total compensation of $641,098. For simplicity, we’ll assume the stock price doesn’t fluctuate, and that the RSUs are received in four equal increments on Feb 15, May 15, Aug 15, and Nov 15. We’ll also assume they max out their 401k contributions at $23,000 pre-tax, make no other pre-tax contributions, and take the standard deduction. Additionally, we assume they live in a high cost locale like New York City. Finally, we assume they are filing as Single. This would make them subject to $181,599 in federal taxes.

Throughout the year, the following taxes will be deducted from their income:

• Base Salary: Taxes on each paycheck you receive are effectively calculated by multiplying the amount in that paycheck by the number of periods to get an annualized amount (subject to a few adjustments, such as Form W-4). The federal tax for that annualized amount is then calculated and divided by the number of pay periods, to figure how much you owe in that pay period. The net effect is that even though we know that this SWE is making over $600k this year, they’ll only be taxed on their base salary as if they were making $254,599. That works out to $53,208 in taxes withheld, using this table⁴.
• Bonus: Bonuses can be withheld at the same 22% supplemental income rate, meaning the SWE’s $38,283 has $8,422 in taxes withheld.
• RSUs: Using the 22% rate, $76,607 in taxes are withheld from the $348,216 in RSUs the SWE earns.

Adding it all up, the SWE would have had $138,237 in taxes withheld, of the $181,599 they owed. They need to withhold at least $163,439 to meet the 90% safe harbor rule discussed above (for simplicity, we’ll assume that the 90% safe harbor rule is the one that is the lesser of the two for our SWE). The result is that the SWE needs to fork over an extra $25,202 to the IRS on time, or owe that 8% penalty.

Below, I’ll break down some different ways our SWE can get the IRS their money, and potentially profit along the way.

The Base Case: Increase Withholdings to 90% of Taxes Owed

If our SWE wants to keep it simple, they can just ask Meta to increase their withholdings. Form W-4 lets them ask for more money to be withheld from their paycheck. While I do not know of an IRS-required way to request extra withholdings from RSU vesting, Meta does offer that option to their employees. For individuals who’s companies don’t provide an option for extra RSU withholdings, they can increase paycheck withholdings to compensate for it or pay estimated taxes (both discussed in the following sections). This scenario will be the base case we compare all the other options to.

Pay Estimated Taxes with a Credit or Rewards Debit Card: $297-$2,541 Tax-Free Profit

Those who expect to owe the IRS money can make estimated tax payments, which are made as quarterly payments throughout the year. There are different methods for determining the payments you make, with the simplest being regular equal installments. Consistent across all methods is that you have to pay every quarter to avoid penalties, you can’t just back load all payments to the last day of the year.

What makes estimated tax payments profitable is that you can pay them with a credit or debit card. The various payment processors do charge a fee, but currently the cheapest option is 1.82% for credit cards and a flat $2.14 for debit cards. The main ways I’ve made this profitable in the past have been:

1. Use a credit card that earns more than 1.82% back: Currently, I use the PayPal 3% back credit card (not a referral link) to pay my taxes. If our hypothetical SWE did this, they’d net out to a $25,202 * (3% – 1.82%) = $297 profit for paying their taxes. As a bonus, the PayPal credit card can be paid off with a debit card over the phone, meaning you can also earn money while paying off the card, if you have a rewards debit card. Assuming 15 min / payment, this fits into the $200/hour rule. Note that if you’re thinking of getting this card, you can usually pull up a $50 bonus for signing up if you start the process through the PayPal app.
2. Get a new credit card and pay taxes to meet the sign up bonus: Paying taxes is a huge part of how I made $7k from credit card sign up bonuses in 2023. Given that the estimated tax payments are spaced three months apart, and most sign up bonuses give you 3-6 months to meet the spend requirements, our SWE would need at least two cards with sign up bonus to have every dollar of their tax payments go towards sign up bonus minimum spend requirements. For simple math, let’s assume our SWE gets a $750⁵ Chase Ink⁶ Cash card each quarter⁷, and uses their $6,300 quarterly payment to meet the $6,000 minimum spend. Those cards have no annual fee, so the profit is $750 * 4 – $25,202 * 1.82% = $2,541. This process is more involved (I usually assume an hour or two of overhead per new credit card), but even at the worst case of 8 hours of time, it fits into the $200/hour rule.
3. Use a rewards debit card where even a small amount of points outweigh the $2.14 fee: I previously used the now-defunct Nearside Debit Card to earn 2.2% back on tax payments. If that card still existed (or if they could find a similar one now), our SWE could earn $25,202 * 2.2% – $2.14 = $552.

A final perk is that putting the payment on a credit card allows you to defer payment until your credit card bill is due. Depending on where you are in your statement cycle, this could be as little as 21 days (but by law, no fewer!), or closer to 50⁸. Let’s assume the average of 36 days for our SWE. If they have a setup like mine for short term cash, they can be earning 5% in interest on the money while it sits waiting to be used. Over the course of that 36 days, our SWEs $25,202 will earn another $124 in interest.

So in this scenario, our SWE can make between $297 + $124 = $421 and $2,541 + $124 = $2665 from credit and debit card rewards, with the added benefit that these generally tend not to be subject to taxes.

Back Load Paycheck Withholdings and Invest the Money in the Meantime: $275 Profit

I’ve talked before about the time value of money, and the concept comes up again here; it’s almost always better to pay the same amount of money later rather than earlier. This is because every day you defer a payment, you can invest the money you have to pay, and keep the return. The way our hypothetical SWE can exploit the time value of money in this current tax situation, is by maxing out the federal tax withholdings at the end of the year, to just get them over the bar into the 90% safe harbor. 

This time shifting of tax payments is possible with paycheck withholdings, but not estimated taxes, because the IRS does not place quarterly requirements on paycheck withholdings like they do on estimated taxes. Instead, when calculating penalties, they just check that the amount withheld from your paycheck throughout the year is greater than 90% of the taxes you owed or 110% of what you paid last year⁹. To achieve this extra withholding, you can use Form W-4 to request your employer withhold an arbitrary amount of extra money from each paycheck (note that employers often have deadlines for payroll modifications, so don’t expect you can submit a W-4 the day before your paycheck and have it reflect your changes; make sure to give some notice).

Looking at our theoretical SWE, if they have 26 pay periods, they would receive $9,792 each pay period. They would have $2,046 in federal taxes withheld already, and we’ll assume another 15% is deducted for state taxes, city taxes, Medicare taxes, health premiums, etc., adding up to $1,468¹⁰. This leaves our SWE with $6,278 per pay period they can ask to be additionally withheld, meaning they can pay their extra $25,202 in taxes in roughly 4 pay periods. We’ll assume that that means they start this extra withholding November 1st.

So from January 1st to November 1st, our SWE is underpaying their taxes, and investing the difference in a safe investment like the FDLXX money market fund (I talk more about short term cash storage options in this post). FDLXX is returning 5% in May 2024, and we’ll assume that it has that return for the whole year. By the time November 1st hits, our SWE will have made $466. They can then take all that money out of their money market fund, and use it to cover their costs while their paycheck is reduced to $0. Note that these earnings are subject to federal taxes, but are tax free at the state level due to FDLXX being made up of US Treasuries. So the $466 is only reduced by the SWE’s 37% federal marginal tax rate and the 3.8% Net Investment Income Tax, for a final number of $275.

Accept the Penalty and Gamble on the Market: $5,555 Loss to $2,345 Profit

In 2021, the IRS underpayment penalty was 2% for the whole year. Funds like FDLXX had a return of 0.01% that year. Given that the S&P 500 has an average annual return of over 10%, however, many argued at the time that it was worth accepting the penalty and investing the money in the market. After all, a 2% rate for a margin loan in an investment account would be pretty good! In 2024 with an 8% penalty, this logic might be a bit less compelling.

Regardless of the interest rate, this option doesn’t match my risk appetite, and I personally wouldn’t try it. While it’s true that the S&P 500 averages 10% over its lifetime, in some years it looses 9%, 21%, and even 36%. Wouldn’t it suck to have to sell at a loss just to pay your taxes? I’m a firm believer in an equity heavy portfolio for long term wealth building, but their volatility carries a lot of risk for money that you need to access on a short term deadline.

It’s always possible to tap other funding sources to avoid selling at a loss, like I talk about in my emergency fund post, but those are short term options that could end up being even more expensive than selling at a loss if the market stays down and you have to use them for a long period. And yes, you could always use your most recent RSU vest or bonus to pay your taxes instead, but that means you’re missing out on investing that cash at what is clearly a market low.

One final note is that the investment gains you make are taxable, and the 8% penalty is not deductible. So even if you earn the average 10% S&P 500 return, taxes will likely reduce it below the 8% penalty.

Running the numbers for historical S&P 500 returns and accounting for the 8% penalty, we see that in the S&P 500’s worst year, our SWE would have lost $5,555 using this strategy. In its best year, they would have made $2,345. In an average year, however, they would have lost -$540. All these numbers are after accounting for taxes on the S&P 500 gains.

Paying 100% of Taxes Owed

Some people, regardless of what method they choose above, may not want to toe the line by paying the bare minimum they have to. Instead, they may want to target paying 100% of the tax they owe. This forgoes the opportunity to put that money in some sort of safe investment until Tax Day, leading to the same sort of time-value of money discussion as in the “Back Load Paycheck Withholdings” section. If our hypothetical SWE did this, they’d miss out on about $437 in post-tax returns. 

Paying the Top Marginal Rate

For those that both a) don’t want to pay the 8% penalty for underpayment and b) don’t want to try and figure out their effective tax rate, could just default asking the company to withhold taxes at their marginal tax rate (the top tax bracket they’re subject to) instead. This has the upside of not having to do a bunch of complicated math and guestimation. This has the downside of causing you to give the government money you didn’t owe, causing you to miss out on potential growth until the government gives it back to you when you file your tax return.

Money that was over-paid to the government could instead have been invested over a long time horizon in something like the S&P 500 (assuming you had no other immediate need for it). Given the average 10% return of the S&P 500 and the assumption of holding it for > 1 year, our SWE would miss out on $4,033 in post-tax gains by over paying their taxes at the 37% marginal rate vs. investing the money¹¹.

Hopefully this shows it is worth taking the time to properly estimate your taxes owed and not over pay, even if that means paying to have an accountant do the work for you. If you want the simplest way to make sure you’ve hit the safe harbor without maxing out your withholdings, just calculate 110% of the taxes you owed last year and shoot for that number instead¹².

FAQs

Isn’t that a lot of work, for not that much return?

Biggest chunk of work is figuring out what you owe, and you have to do that regardless of whether you’re trying these tricks to make a profit. Figuring out what you owe ahead of time can be tricky, given that RSUs vary in price (unlike the assumption I used for our SWE above), so you can’t even know your true tax rate until your final vest! If you’re looking to reduce complications, just target 110% of what you paid last year; that’s what I’ve been doing.

Once you know what you have to pay, you have to figure out how to pay the government regardless of whether you use the above tricks. In my mind, the incremental work is minimal to go from adjusting withholdings to paying estimated taxes by credit card. So, for me, it’s worth the extra effort for the return.

I’m not an E6 SWE at Meta. Does this apply to me?

Obviously, this only applies to those who are under-withheld during the year, usually due to supplemental income being withheld at that 22% rate. If that applies to you, the rest becomes a question of scaling.

The profitability of the methods discussed in this post scale linearly (to an extent) with the amount of taxes you need to pay to hit the 90% safe harbor threshold. The taxes needed to hit that threshold, however, do not scale linearly with total compensation. This is because as your total compensation goes up, your effective tax rate goes up¹³, but your supplemental income tax withholdings (ie. RSU and bonus withholdings) stay constant (at least until you reach >$1 million in supplemental wages). So each additional dollar you earn is undertaxed more than the prior dollar. In the other direction, the underpayment of taxes shrinks non-linearly with compensation, until the point where it resides wholly in the 90% safe harbor threshold. As an example, when I ran the number for a E5 SWE at Meta, it worked out to ~$5k in taxes that needed to be paid to hit the 90% threshold. 

Another note on scaling is that the method of credit card points and bonuses do not scale forever. Many cards have limits on the amount you can spend at their lucrative 3%+ rates. For signup bonuses, there are some large bonuses with large spend out there (eg. 300k Amex points for $20k spend), but there’s a limit to how many you can get without having to get creative.

Footnotes

1. Note that I say things like “are allowed to” and “can be” when referring to the 22% rate, because there is more than one method employers can use to calculate tax on supplemental wages. Another method allows employers to calculate taxes by calculating your taxes as if you were earning the amount of your bonus / RSU grant in every pay period for the entire year. This obviously results in an incredibly high tax rate that over-withholds taxes. If your company does this, a) I’m sorry, and b) you may not end up with an underpayment. In those cases, you might end up with a tax refund at the end of the year instead. ↩︎
2. If you’re lucky enough to make over $1 million in supplemental income (ie. RSUs / bonuses), the amount over $1 million is withheld at a 37% rate instead. ↩︎
3. You may have heard 100%, rather than 110%, thrown around as the percentage of last year’s taxes you need to pay to avoid a penalty. 100% is the default number, but once you have an adjusted gross income (AGI) over $150,000, the threshold goes up to 110% ↩︎
4. The exact math, if you’re curious, is: $37,417.00+0.32*($254,599-$205,250) = $53,208. This math is a simplification of Step 2 of Worksheet 1A in this IRS publication ↩︎
5. Technically this card give Chase Ultimate Rewards points, which can be used for Chase Pay Yourself Back at > $0.01 per point or redeemed for flights at even higher rates. I’m keeping things simple here, however, and just valuing them at $0.01 per point to be conservative. ↩︎
6. Yes, this is a business card. You’d be surprised how easy it is to get a “business” card. I personally have done software contracting in the past and use that to justify my business cards, but many others have gotten business cards with much less justifiable businesses (e.g. “I occasionally sell stuff on Facebook Marketplace”). Business cards can usually be applied for with just an SSN (no corporation needed), and many do not report on your personal credit report. ↩︎
7. Yes, it is actually possible to get more than one of these cards. There are also multiple Chase Ink cards that earn similar sign up bonuses, if you don’t want duplicates. ↩︎
8. There is a micro-optimization here where you could even get creative and ask your issuer to move your statement close date to the day before you pay estimated taxes, to maximize the time you get to pay it off. Given that estimated taxes are always due on the 15th (or later if a weekend or holiday), you’d want to have your statement close by the 14th. Every extra day is worth $3.45 on our SWE’s $25,202 payment at a 5% rate, so this truly is a micro-optimization, but it does slowly pay off over time if you’re always using the same card. ↩︎
9. You can see this from the penalty calculation on Form 2210. Line 9 says that if your total withholdings (Line 6) are bigger than 90% of this year’s taxes (Line 5) or 110% of last year’s taxes (Line 8), then you don’t owe a penalty. ↩︎
10. My number worked out to 13.5%, but I’m trying to use the most conservative interpretations here. Obviously, this number will be a lot lower for you if you live in a place with no city / state income tax ↩︎
11. Note that –as I harped on above– the S&P 500 doesn’t go up every year. But given that I’m assuming this money wasn’t needed for any other purpose, it can be kept invested for years. In that case, it doesn’t matter if the first year is a down year, so long as we believe that over the long term the S&P 500 will continue to average 10% over the long run. ↩︎
12. This assumes your total compensation hasn’t dropped dramatically since last year. If it has, this number could end up working out to even more than you max marginal rate! ↩︎
13. Your federal effective tax rate asymptotically approaches 37%, as a larger and larger fraction of your total compensation is subject to that rate. ↩︎