Today I want to talk to you about RSUs.
These days, a lot of companies pay employees partly in restricted stock units. You get a grant, the shares vest over a few years, and then you own the stock.
When shares vest, the full value counts as ordinary income that day. It goes on your W-2 and gets taxed like salary. This happens whether you sell the shares or not. Vesting is the taxable event, not the sale.
Most employers withhold a flat 22% for federal taxes when RSUs vest. That’s the IRS supplemental wage rate, and it applies to bonuses too. The problem is that 22% is just the withholding. Your actual tax on that income is whatever your marginal bracket is.
Take Kristin. She earns $240,000 in salary and has $60,000 of RSUs vesting this year. Her employer withholds 22%, which is $13,200, usually by selling enough shares to cover it.
If her marginal rate is 32%, she owes $19,200 on that vest. She’s $6,000 short, and she finds out when she files her return. State taxes can make the shortfall bigger.
The payroll department didn’t do anything wrong. The 22% rate is the default and it applies to everyone the same way. It just doesn’t match a 32% bracket.
There’s an exception at the top. Once supplemental wages pass $1 million in a year, the withholding rate goes to 37% on everything above that. Most people never get there.
Also, your cost basis in the shares is the vesting-day price. Sell later at a higher price and the gain is a capital gain. Sell right away and there’s usually not much gain at all.
Now the planning part, which is the more useful half.
The simplest fix is a new W-4. In Step 4(c) you can ask your employer to withhold an extra dollar amount from each paycheck. If you’re $6,000 short and paid biweekly, that’s about $231 extra per paycheck for the rest of the year.
The W-4 beats writing the IRS a check for one reason: withholding is treated as if it were paid evenly through the whole year, no matter when it actually came out of your pay. So bumping your withholding in October can cover shortfalls from earlier quarters. A fourth-quarter estimated payment can’t do that. Estimated payments only count for the quarter they’re made in, and the September deadline just passed.
The other number worth knowing is the safe harbor. If your withholding and estimated payments add up to 100% of last year’s total tax, there’s generally no underpayment penalty, even if you still owe money in April. The threshold is 110% if your adjusted gross income was over $150,000 last year. And if your balance due is under $1,000, there’s no penalty at all.
One last thing. Whether to sell the shares after they vest, hold them, or do some of both is a separate decision from the tax question. That’s a different post. And if you know a big vest is coming early next year, do this math in January, not the following April.
The action item here is to compare your withholding rate to your marginal rate and close the gap during the year instead of at tax time. Talk to your advisor and have them pull in a tax professional like an EA or CPA so you can work through all of this based on your specific situation.
