Consultants and software engineers, especially early in their careers, often face tax issues that catch them by surprise. For example, travel can mean filing in several states, and bonuses and equity can throw off your withholding. This guide covers the main tax areas consultants and software engineers should watch.
You may need to file in more than one state
Consultants often work at client sites in other states for weeks or months. As a result, several states may tax part of your wages. Your W-2 may show more than one state in boxes 15 through 17.
Your home state usually taxes all your income. However, it generally gives you a credit for tax you pay to other states on the same income. A common mistake is forgetting to claim that credit, which means paying tax twice. So check each state’s rules, and keep your travel records.
Employer-paid tuition can be taxable
Some firms pay for an employee’s MBA or other degree as a loan. Then they forgive the loan over time if the employee stays. When the firm forgives part of the loan, that amount usually appears on your W-2 as taxable wages. So you may owe tax on money you never received in cash.
Unfortunately, employees can no longer deduct unreimbursed job-related education on their federal returns. However, certain education assistance programs let employers provide up to $5,250 a year tax-free. So ask your employer how your program is set up, and plan for the tax in the years the loan is forgiven.
Optimize your retirement savings
Many software engineers sign up for a traditional 401(k) on day one and never revisit it. However, many plans also offer a Roth 401(k). With a Roth, you pay tax now, and qualified withdrawals in retirement are tax-free. By contrast, a traditional 401(k) lowers your tax now and taxes withdrawals later.
Early in your career, when your tax rate may be lower, Roth contributions can make sense. In addition, high earners who can’t contribute directly to a Roth IRA may consider a “backdoor” Roth IRA. For the current limits, see our guide to Roth IRA vs. 401(k).
Bonuses and equity can throw off withholding
Bonuses are taxed like any other wages. In other words, $100,000 of salary plus a $50,000 bonus is taxed the same as $150,000 of salary. However, employers usually withhold federal tax on bonuses and RSU income at a flat 22%. For many high earners, that’s too low.
As a result, you may owe a large balance, and possibly a penalty, when you file. To avoid that, adjust your W-4 or make estimated payments. For RSU holders, see our guide to restricted stock units. For the IRS rules, see the IRS Tax Withholding Estimator.
Key takeaways for consultants and software engineers
- Multiple states: file in each state that taxes your wages, and claim credits so you don’t pay twice.
- Employer-paid tuition: plan for tax when the loan is forgiven.
- Retirement: consider Roth contributions early in your career.
- Withholding: check it after bonuses and RSU vesting.
Get help with your taxes
We help consultants and software engineers with multi-state returns, equity and withholding planning. To learn more, call (415) 842-2940 or book a free 15-minute call.