What is IRS Form W-4 and how does it apply to withholding from stock compensation?
IRS Form W-4 determines how much federal withholding tax will be deducted from your paycheck, at least from your salary. If you are an employee, you completed it when you were hired. You want to submit a new Form W-4 to adjust your withholding whenever your personal or financial situation changes.
Generally, when a company withholds federal income tax on supplemental wage payments from stock compensation or a cash bonus, it can choose to withhold at the flat supplemental rate or at the payroll rate according to your Form W-4. In Publication 15-T, Federal Income Tax Withholding Methods, the IRS covers how companies use W-4 information to calculate withholding. Usually your company does not use your W-4 rate but instead applies the tax rate for supplemental wage income (22% up to $1 million and 37% for yearly amounts in excess of $1 million). If your company allows, there are steps you can follow for it to apply the W-4 rate.
IRS Revised Form W-4 In 2020
In 2020, the IRS introduced a revised Form W-4 that better aligns with the Tax Cuts & Jobs Act (TCJA), which eliminated allowances and exemptions. You can use special lines on this form to avoid owing more taxes with your tax return or having to pay estimated taxes.
Somewhat like the prior version of Form W-4, Line 4(c) of the modified Form W-4 says: "Extra withholding. Enter any additional tax you want withheld each pay period." This could be used after a taxable event with your stock compensation in which you believe the flat rate withheld amount is less than the actual tax owed according to your marginal tax rate. You need to know the timing/advance notice your company requires to implement the change. This additional withholding from your paycheck will continue until a new W-4 is filed.
While there is no withholding for capital gains on company stock sales, assuming backup withholding does not apply, the new W-4 does provide a way to withhold at least from salary income the taxes you expect to owe. See Line 4(a), which says: "Other income (not from jobs). If you want tax withheld for other income you expect this year that won't have withholding, enter the amount of other income here."
IRS Guidance And Other Resources
As explained in the IRS FAQs on the revised W-4, employees hired before 2020 do not need to complete the new W-4 unless they want to adjust their withholding. The IRS also developed a revised tax-withholding estimator to help, along with a YouTube video. Married joint filers should include both spouses' income in the calculation. While the IRS estimator tool works for most people, the IRS explains that people with more complex tax situations should use the instructions in Publication 505, Tax Withholding And Estimated Tax. That includes taxpayers who owe the alternative minimum tax and those with long-term capital gains or qualified dividends.
For employers, the American Payroll Association has developed a sample model letter that explains the changes to employees.
A Kiplinger article has some insights on various aspects of the revised Form W-4: 10 Things Every Worker Needs To Know About The New W-4 Form For 2020.
Further details are explained by an article from ADP: Final IRS 2020 Form W-4 Released.
Steps for completing the form are presented by an article from the website NerdWallet: How To Fill Out Form W-4: Calculator, Tips & FAQs For 2020.
The IRS has published tips for taxpayers who need to file a new Form W-4.
See also an article from Bloomberg Tax: When Is The Time To Consider New Withholding On The W-4? Always