Squarespace & Income Tax Withholding Rules

We’ve been talking to a lot of Squarespace employees this week. So there’s a message I wanted to share as it relates to tax but more specifically to Squarespace folks. However, this could also apply to anyone who’s going through a transaction similar to this. If you haven’t noticed in the news, Squarespace is going private. That transaction has been approved and employees will start receiving proceeds (hopefully soon) for their equity compensation that’s involved in that transaction.

TAXES

The top thing I want Squarespace employees to know is that even though you’re going to see a lot of tax withheld from the proceeds from this transaction, this is a number of different taxes:

• Federal Income tax
• State income tax (if you live in a state with income tax)
• Social Security
• Medicare

It will feel like a lot of taxes are being withheld. It could be up to 40%-50% depending on the rates in your state. 

It’s important to keep in mind that the IRS views stock compensation as supplemental compensation. Supplemental compensation has a separate and distinct federal withholding tax rate, and in a lot of cases, a state rate as well, that is unique to supplemental compensation. It ignores everything that you put on your W-4 for withholding purposes. 

SURPRISE!

We see a lot of employees and clients that come to us the year after a big transaction like this, and they’re surprised at the federal tax balance due that they owe on their return. That could be because their withholding was set really well prior to this transaction. In most years, they may have a little bit of a balance due with the IRS, maybe a little bit of a refund, but for the most part, things are right on track. Then boom, we get this big transaction. All of a sudden there’s a huge federal tax liability at the end of the year, and it catches people by surprise all the time. The important thing you need to remember is supplemental compensation per IRS rules, meaning the standard rate of withholding for IRS federal income tax purposes, is 22%. It’s also important for you to know what your tax bracket is, what your marginal tax rate is. Tax brackets in the US for federal purposes go all the way up to 37%.

This means you could be underwithheld on your supplemental compensation by up to 15% of the value. It’s important to realize this ahead of time before you deploy all those proceeds. You want to have money left over in your account if you think that you’re going to have some underwithholding.

HOW YOU CAN PREPARE

Here are some steps that Squarespace employees should take: 

1. Double check what your tax bracket is going to be, what your marginal tax bracket – basically the highest tax bracket that you’re going to be subject to this year. It might be different than before depending on the size of your equity award.
2. Know that the default rate for withholding on this compensation for federal income tax purposes only, not all those other taxes that we were talking about, is 22%. 
3. Figure out the difference between those two numbers above and make sure that you’re setting aside some of that cash to pay taxes for next year. 
4. Check and see if you need to make any estimated tax payments this year. You may not if this is a much higher income year than normal, but verify those rules on estimated payments and see if they might apply to you.

Equity compensation is good news for Squarespace employees. It’s really great to receive those proceeds, but you gotta watch out for taxes. And that applies for anybody else going through a transaction where they’re getting some liquidity on equity compensation. 

If we can help out, please follow go to our website and book an intro call. We’d be happy to talk to you.