
How Equity Comp Earners Can Avoid Paying More Tax Than Necessary
FINANCIAL ADVICE | GUIDANCE | INSIGHTS | OBSERVATIONS
Equity compensation might not look like a regular paycheck, but that doesn’t mean the IRS won’t want its share come tax time.
Stock options, restricted stock units (RSUs), employee stock purchase plans (ESPPs), and other forms of equity give employees a stake in their company’s success. They can be a valuable component of an overall compensation package, substantially increasing income and helping to build long-term wealth.
But these attractive benefits also come with their own set of challenges – and limiting your taxes owed and avoiding penalties rank high on the list.
Read on for an overview of seven common mistakes that you can easily avoid!
Key Findings
Participating in an equity compensation program can increase your income and help you build long-term wealth.
Equity grants are subject to complex tax rules. If you’re not prepared, you may pay more in taxes than you need to.
Working with an advisor and CPA who specialize in equity compensation can help you make the most out of your plan and avoid pitfalls that may result in an increased tax bill and penalties.

Because the various types of equity awards have different tax implications, it’s important to understand how and when you’ll be taxed to avoid paying more than necessary.
How is Equity Compensation Taxed?
Tax rules vary based on the type of award you receive. Here’s a brief overview of how the different types are taxed:
Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs)
RSUs and RSAs are typically considered supplemental wages, and taxes are withheld when they vest.
These wages — which may include cash bonuses and other types of compensation in addition to RSUs — up to $1 million are subject to a 22% federal tax withholding. Additional supplemental wages over the $1 million threshold are taxed at a rate of 37%.
For example, if you receive $1.1 million in supplemental wages, the first $1 million would be taxed at a rate of 22%, and the remaining $100,000 would be taxed at a rate of 37%.
People who receive RSUs and RSAs often sell shares to pay their tax bill, but you can also pay in cash or opt for payroll deductions to cover your tax burden. Additionally, any realized gain above the fair market value on the vest date is subject to short- or long-term capital gains tax when you sell.
Nonqualified Stock Options (NSOs) and Incentive Stock Options (ISOs)
If you receive non-qualified stock options as part of your equity compensation package, taxes are withheld at the time of exercise.
NSOs are subject to a 22% or 37% federal tax withholding, depending on the value of the shares. However, no taxes are withheld from ISOs at any time, leaving you responsible for covering the tax bill as necessary. Depending on the value of the options exercised and the timing of when you sell the shares, you may need to pay alternative minimum tax, ordinary income tax, or no income tax.
Employee Stock Purchase Plans (ESPPs)
Employees participating in an employee stock purchase plan don’t have to pay taxes until they sell the stock.
The discount at which you purchase company stock through an ESPP is taxed at your ordinary income tax rate, and you’ll have to pay capital gains tax on any realized gain. The taxable discount is determined based on how long you hold the stock position. Favorable tax rates can apply for a qualifying disposition.

Since equity grants are subject to complex tax rules, if you’re not prepared, you may pay more in taxes than you need to.
7 Common Mistakes to Avoid
1. Not Withholding Enough for Income Taxes
Problem: Although taxes are automatically withheld when RSUs and RSAs vest and NSOs are exercised, that withholding is often insufficient to cover the tax bill they generate. And other types of equity grants, including ISOs and company stock from an ESPP, have no taxes withheld when you exercise your options or sell your shares.
Solution: Fortunately, there are things you can do to avoid getting blindsided by a large tax bill or underpayment penalty when April rolls around, including:
- Temporarily updating your W-4 withholding election to withhold a specific dollar amount when restricted stock vests or options are exercised. You can also increase your withholding on other wages, such as your salary.
- Making an estimated tax payment in the same quarter that you sell shares or exercise options.
- Paying 110% of last year’s tax liability. While this can help you avoid paying an underpayment penalty, you may still owe a lot when you file your taxes, which could create a cash flow problem.
2. Not Understanding Equity Grants
Problem: If you aren’t aware of what triggers a tax event and the potential implications regarding how much you’ll pay, you could get hit with an unexpected tax bill or pay more than you need to.
For example, restricted stock vests automatically and is taxed as ordinary income based on the value of those shares on the vest date. If the value of your company stock has increased substantially since the original grant was issued, the amount of taxable income you receive could be much higher than expected.

You may be under-withheld if you don’t take proactive steps to increase your withholding or make an estimated tax payment.
Solution: Carefully review your plan documents to ensure you understand the type of grant you’re receiving, the vesting schedule, expiration dates, tax treatment, trading windows and holding period requirements.
Understand how price movements throughout the year may impact your tax situation — if at all. Consult with your financial advisor to develop a tax strategy so you only pay what you need and nothing more.
3. Focusing Too Much on Taxes
Problem: Many people are reluctant to sell or roll over their shares because they don’t want to pay taxes. Taxes are important, but they shouldn’t be the only factor you consider when deciding whether to hold or sell an equity grant. Hanging onto an award just to avoid a tax bill may not be in your best interest.
Do what’s best in the most tax-efficient way, but don’t be afraid to sell an equity grant because you don’t want to pay taxes on it.

Solution: Be sure to consider other factors which may be just as or more important than the tax consequences, such as:
- Achieving Your Goals: Selling grants may help you achieve short- to intermediate-term goals, such as buying a house or funding your child’s education.
- Your Overall Portfolio: Keeping too much of your portfolio in company stock can be risky. Diversifying your investments can help mitigate risk, even if it means paying taxes when you sell.
- Minimizing a Loss: Although tax treatment of a qualifying disposition is more favorable, holding onto a stock until it reaches that status may not be in your best interest if the value of the stock drops. The benefit of more favorable tax rates can be lost if those rates apply to shares that are worth substantially less in value.
4. Not Double-Checking Your Tax Forms
Problem: When you sell stock or exercise options, it’s not uncommon for that information to show up incorrectly or as “cost basis unknown” on your tax forms. If the information isn’t accurate, you could end up paying taxes twice on the same gain.
Additionally, if you forget to provide tax forms to your CPA regarding an event that didn’t occur in the last year, they will have no way of knowing about the new source of income. They will prepare your taxes based on last year’s return, and you may not pay all the taxes you owe as a result.
Solution: Compare the information on your tax forms to your account’s activity for the year, including what sold, what vested, and at what price. Most major providers that service equity compensation plans allow you to download a spreadsheet showing your equity compensation activity for the entire year.
You also need to let your CPA know if there is anything new on your taxes for the year to ensure you pay the appropriate amount.
5. Waiting Too Long to Sell
Problem: Holding onto ISOs through the end of the year without a plan for paying alternative minimum tax (AMT) can result in less favorable tax treatment.

Solution: If you plan to exercise ISOs to purchase publicly traded stock, and you know it will trigger a substantial AMT liability if those shares are held through year-end, consider exercising your ISOs in January and using the proceeds to cover your AMT liability from the previous year.
Exercising early in the year gives you the best window to decide if you want to have a qualifying or disqualifying disposition at the end of the year. Alternatively, you might consider exercising the maximum number of shares you can in December without triggering an AMT bill for the year.
6. Defaulting to a “First-In, First-Out” Strategy
Problem: It’s not uncommon for brokerage firms to default to a “first-in, first-out” tax treatment when stock is sold. You’ve likely held the first shares you were awarded long enough to qualify for the long-term capital gains tax rate, but those shares may be the most expensive to sell, with the highest unrealized gain.
Solution: Decide which lots (within each grant and across all grants) are the most tax-efficient to sell. Additionally, if you need cash or want to diversify your portfolio, it often makes sense to sell RSUs as soon as they vest. Because they are taxed as ordinary income when they vest, there’s no tax incentive to hold onto them.
7. Neglecting to Diversify / Concentrating Employer Stock
One mistake we see equity comp earners make is neglecting to diversify their portfolio and concentrating their employer’s stock. This carries concentration risk, which can make your plan become less successful if that company doesn’t perform well.
So while rapidly-appreciating positions in employer stock are great on one hand, on the other, being extremely concentrated can see you stuck with unwinding a tax problem at the same time you’re trying to balance diversifying your portfolio. And there isn’t necessarily an easy solution in that scenario.
How an Advisor Can Help With Equity Compensation
At WestStar, we understand that equity compensation is complicated.
Working with an advisor & CPA who specialize in equity awards can help you make the most out of your equity compensation plan and avoid pitfalls that may resulted in an increased tax bill and penalties.

Your advisor can also incorporate expected awards into your long-term wealth management plan and develop a plan to divest company shares to create a more diversified portfolio.
If you have questions about your specific circumstances, or want to talk about developing a financial plan to address your goals and aspirations effectively, please get in touch.
We welcome the opportunity to chat with you and wish you every success in the future.
Sam Gullette & Erik Alexander

Sam Gullette, CFP®, CLU®
Certified Financial Planner™
‘My mission in life is to help people take control of their money and avoid financial stresses. My clients are successful professionals and executives, many of whom are compensated heavily with company stock. Together we maximize their wealth-building opportunities, minimize taxes, and make sure their family is protected if life throws them a curveball.’

Erik Alexander
Financial Consultant
‘I work with professionals and executives who are compensated through various forms of company stock. They have more money than time and struggle to balance the key aspects of their lives. Their decisions affect others, and they feel a huge responsibility towards making them wisely. I enjoy helping them solve their complex problems, and being counted on for their and their families’ financial wellbeing.’
The views stated in this article are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein or as a recommendation of any kind. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
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Cetera Advisor Networks LLC exclusively provides investment products and services through its representatives. Although Cetera does not provide tax or legal advice, Cetera representatives may offer these services through their independent outside businesses. This information is not considered as tax or legal advice.