Lump sum paycheck taxes?

May 17, 2019 6:55 AM

I am a professor and I work on a 9 month contract, but the pay is stretched over 12 months and paid out every 2 weeks. I am moving to a different university so I resigned from my current one, which then decided to pay out in a lump sum the rest of my pay from this year's contract - 6 pay periods. Will their decision to pay it in a lump sum instead of twice a month through the end of July change the sum total of taxes I will need to pay?

Initially I received a lump sum that was rather lower than if you multiplied what is direct deposited in one pay period times six, and after I emailed them to ask how they landed on their lower number, they said it had to do with how they calculated taxes on it. They said I would get the missing amount back in a tax refund next April (would that have been true?), and I said how about now instead, I don't want to wait a year. So they said they could calculate it a different way and they then deposited more into my account - but meanwhile, I've been googling lump sum payments (which gives me info about bonuses and severance, so I can't tell if that info pertains to my issue) and I'm still confused because I think it could be the case that I just owe higher taxes if they choose to pay me all at once...(which obviously I don't want, but does that mean I need to go back and talk to my former employer again)?

So if what I have now received is approximately (very slightly more than) my normal pay period times six in one lump sum (well, two now), will my end-of-year taxes be approximately normal as well or will I owe more in taxes due to this lump sum putting some part of my earnings into a higher tax bracket? Is there something more I should do or is it all good now?

posted by vegartanipla to Work & Money (10 answers total)

Best answer: Taxes are based on annual earnings, getting $100 a day every day is the same as getting $36500 on a single day: January 1, December 31 or anything in between.

Payroll deductions are usually made on the assumption that you will have the same income all year, so that may be the source of the weirdness.
posted by Homeboy Trouble at 7:02 AM on May 17, 2019

Best answer: The timing of your income won't change your tax liability at the end of the year, but it will change the amount withheld from your paycheck, essentially because it seems like you're making more and will be subject to a higher tax bracket. So whether or not you are paid $1000 a week for 52 weeks starting January 1st or $52,000 once a year on December 31st, you would have the same income, and the same tax liability either way. Your total income for the year will determine what tax bracket you are in.

If the amount you are getting now is close enough that it doesn't make a different to your ability to pay bills/live life, I wouldn't worry about it at all and just count on it being either a small decrease in the amount of refund you get or a small increase in the amount of tax you owe. But there is nothing different about lump sum bonuses, they are counted as income just like wages.
posted by skewed at 7:04 AM on May 17, 2019 [7 favorites]

Response by poster: Ah, great! Thanks, that's what I hoped for!
posted by vegartanipla at 7:09 AM on May 17, 2019

If you're an employee, it doesn't matter at all when you get income as long as it's all the same year, so you will very likely get a large refund unless you do something else. If you want to compensate, you can raise your estimated deductions when setting up taxes at another job, otherwise you just have to wait. But yeah, there's nothing you need to do.
posted by JZig at 7:09 AM on May 17, 2019

The payroll programs aren't good at modeling you tax liability so you undoubtedly are over withheld. Basically the default is to assume your paycheck represents your ongoing paycheck.

I get about 75% of my compensation in one check and if I don't adjust the withholding in advance I barely owe taxes the rest of the year.
posted by JPD at 7:10 AM on May 17, 2019

So yes, it seems like your employer is treating this payment as supplemental wages, and no I don't know if this is correct or not either. It sounds like they switched from using the aggregate rule (which will almost certainly overwithold) to the 22% rule.

How they do this won't affect your end-of-year liability, but it will mean that your withholdings estimate will be wrong. You'll need to recalculate your estimated taxes and total withholdings (fun!) and adjust the withholdings at your new job to account for this. If you're making close to six figures, then 22% may be too low a rate for that income, and then it's extra important to adjust to avoid underpayment penalites.

I've dealt with this last year on a bonus equity payment from my employer, where they used the aggregate rule, and I ended up with a huge tax refund because my withholdings on it were ridiculously high.
posted by serathen at 7:15 AM on May 17, 2019 [1 favorite]

And as for why the aggregate method was giving you such a high tax rate, it's based on the assumption that this is what you make every pay period. Which makes sense for say, a sales rep whose income varies with commission. But in your case, you were put in a tax bracket as if your salary was six times higher than it should have been.
posted by serathen at 7:24 AM on May 17, 2019

it's extra important to adjust to avoid underpayment penalites.

You will not pay underpayment penalties if you have withheld at least 90% of the current year's taxes or 100% of last year's taxes. Significant overwithholding is not going to cause that unless the person is moving to a job that pays significantly less and meaningfully underwithholds at that job.
posted by praemunire at 8:49 AM on May 17, 2019 [1 favorite]

(Although, reading this over again, I see that OP reports receiving "very slightly more" than OP's normal paycheck x 6 under the 22% rule, meaning that OP must be at least in the 24% tax bracket and thus is being slightly underwithheld for these six pay periods. Still very unlikely that OP will end up out of the safe harbor, unlike, say, a bonus situation where the bonus is 100% base salary or whatever.)
posted by praemunire at 8:58 AM on May 17, 2019 [2 favorites]

The penalties for under withholding are a reasonably small percentage (if i remember correctly, 6%) of the amount you should have withheld. So if you get it wrong by $1k, your penalty (if you owe any, see the 100% of previous year case above) is around $60 per $1000 you're off, as opposed to "the IRS rains hellfire down upon your home."
posted by zippy at 9:07 AM on May 17, 2019 [1 favorite]