How To Avoid A Tax Surprise With An RSU Tax Strategy


Getting Your RSU Ducks in A Row

The majority of our clients at companies like Amazon, Apple, Meta, Nike, Starbucks, Oracle and others are granted Restricted Stock Units (RSU’s) as part of their compensation programs. We call these clients ‘Aviators’ because they have the opportunity to really fly if they get all their equity compensation ducks in a row.

Over the years, we’ve had a great time helping them understand how they should think about their company stock as part of their broader financial plan.

You’ll hear us regularly say that the way a person thinks dictates how they act, and that our actions determine our success. In this sense, your success is directly linked to how you think.  This is why we spend loads of time getting our clients to think in the right way about their equity programs. In this way we help them get all their ducks in a row,

We understand our Aviator clients’ unique financial planning needs, whether they’re just starting out in their career or counting down to retirement.  Given the complexities of their compensation package, it makes sense for them to work with financial professionals who truly understand the ins and outs of equity compensation, especially the IRS rules governing restricted stock, stock options and other forms of equity-based compensation.

Nothing Succeeds like Success

– Alexander Dumas –

We find that once our clients get their thinking right, then success breeds success.

How To Incorporate Your Vested RSU’s Into Your Holistic Financial Plan

As far as the simple nuts and bolts are concerned, Restricted Stock Unit grants allow you to receive shares of your company stock at a specified date in the future.  This may be subject to the achievement of specific performance metrics; but most often, the shares are yours as long as you’re still employed on that future date. This “vesting date” is when you’ll actually see the shares deposited into your account.

To use a real world example, if you received a grant of 1,000 shares of (let’s say) Microsoft stock on August 1st 2022 and the first 250 shares of the stock vest on August 1st 2023, then you’d have received those 250 shares this past Tuesday. Happy days!

The tax treatment of your vested RSU’s is identical to your regular (W2) income.

From Uncle Sam’s standpoint, you are responsible for paying ordinary income tax on the value of those Microsoft shares on the day that they vest. Sticking with our example, if 250 of your Microsoft RSU’s vested this past Tuesday, and the price at that time was $340 per share…then you just added $85,000 to your taxable income for the year.

What you choose to do with the stock won’t alter your tax liability.     

Uncle Sam’s view is that what you choose to do with the stock after Tuesday’s vest will not alter your tax liability. You are responsible for paying taxes on that income regardless of whether you choose to sell or hold onto the shares.

It follows that there is absolutely no tax reason to hold onto Restricted Stock Units after they vest.                                                       

Unlike Incentive Stock Options (ISOs) – where it may make sense to hold onto the shares for a year to realize long term capital gains – you get to pay ordinary income tax on your RSU’s when they vest, no matter what you do with them!

So, you now own 250 shares of Microsoft stock. If you were to sell these on the same day (or soon after it) there may be minor capital gains or losses because the price wouldn’t have fluctuated much from the vesting price.

Alternatively, if you choose to hold onto the stock indefinitely, you will be responsible for paying capital gains on the distribution whenever you do sell.

How Long Should I Hold My Stock If I Elect To Do So?

Providing you hold your stock for more than 1 year, you’ll be taxed at the long-term capital gains rate (a lower rate than the ordinary income rate). Should you hold your stock for less than 1 year, you’ll be taxed at the short-term capital gains rate (which is exactly the same as the ordinary income tax rate).

We ask our clients a simple question to illustrate why they should consider selling their shares immediately. We ask them what they would do if their company gave them an $85,000 cash bonus. Seldom, does someone says they’d buy $85,000 worth of their company stock.

The point is this. Instead of betting the ranch on a single horse in the race, we would look (on behalf of our clients) to diversify that additional income between savings, investments, and retirement accounts and save that money into a broader and more diversified portfolio of equity investments.

What investors need is to have a well-structured portfolio that performs well in different environments.  The most important thing is to have a sound strategic asset allocation mix. There may be no BIG win, but you certainly have well diversified bets with far less risk on the table.

What Are The Rules and Regulations Governing RSU Vesting and Taxes?

While the rules and regulations around RSU’s can be complex, the taxation of RSU’s is fairly simple compared to other forms of equity compensation. Once the RSU’s vest, they are considered taxable compensation. These are some definitions to guide us.

Vesting Period: RSU’s usually have a vesting period during which the employee needs to wait before the units are fully owned.

Income Tax: The value of the vested RSU’s is subject to ordinary income tax. This value is usually based on the fair market value of the company’s stock on the day the RSU’s vest. The income tax rate applied will depend on the individual’s total taxable income and their tax bracket.

Tax Withholding: When RSU’s vest, the company will typically withhold a portion of the vested shares to cover taxes. The amount withheld is generally based on the statutory tax rates for supplemental income, like bonuses. This is called “sell to cover.”

Sell to Cover: Most employers set the default as “sell to cover” so that an employee is not hit with a gigantic tax bill come tax time. Sticking with our example, if your 250 Microsoft shares vested this past Tuesday, you may receive 195 shares and the other 55 shares would be held back or sold (at the 22% federal level) by the company to cover your tax liability up front.

But if you don’t sell to cover taxes on those 250 shares as they vest, you would owe taxes on that additional $85,000 of ordinary income that was not included for the purposes of W2 withholding, and whether you’re in the 22% or the 37% tax bracket…you can do the math!

It’s the same reason why having taxes taken out of each paycheck saves a lot of worry come tax time!

Capital Gains Tax:  Remember, what you choose to do with your stock after it vests will not alter your tax liability. You are responsible for paying taxes on that income regardless of whether you choose to sell or hold onto the shares.

After the RSU’s are fully vested and you become the outright owner of the shares, any future gains from selling the stock will be subject to capital gains tax.  The capital gains tax rate depends on how long an individual held the shares before selling:

  •  If the shares are sold within one year of vesting, any gains will be considered short-term capital gains and taxed at ordinary income tax rates.
  • If the shares are sold after one year from the vesting date, any gains will be considered long-term capital gains, which generally have lower tax rates than ordinary income.

Why do Many Equity Compensation Earners Still Get a Nasty Tax Surprise?

Many prospective clients come to us frustrated from finding that they still owe taxes even after selling to cover their RSU’s.

Here’s where the problem lies: Restricted stock units are typically withheld at the 22% federal level, so if you’re in the 28%, 32% or 37% tax bracket and your RSU’s are being taxed only at 22% withholding, you can expect an unwanted tax liability come tax time!

How Does an RSU Planning Strategy Prevent Tax Surprises?

Avoiding tax surprises requires careful consideration and proactive steps. Here are some tips to help you manage your RSUs and minimize unexpected tax liabilities:

  1. Understand RSU Basics: Familiarize yourself with the basics of RSUs, including vesting schedules, taxation rules, and the difference between a grant and a sale of RSUs. This knowledge will enable you to make informed decisions.
  2.  Consult a Tax Professional: Seek guidance from a qualified tax professional who specializes in equity compensation and RSUs. They’d be able to figure out how much you’ll need on top of your current payments and set up a program to pay that amount throughout the year.
  3. Plan Ahead: Review your RSU vesting schedule and projected income to estimate the tax impact. Consider potential scenarios such as a stock price increase or decrease to gauge the potential tax liability. Understanding your tax obligations in advance will help you plan your finances accordingly.
  4.  Determine a Tax Withholding Strategy: When your RSUs vest, your employer will typically withhold taxes based on a predetermined percentage. However, this may not align with your overall tax situation. You can choose to adjust your withholding to ensure it meets your tax requirements. Consult with your employer’s HR or finance department to discuss your withholding options.
  5. Consider a Sell-to-Cover Strategy: If you receive RSUs and are concerned about the tax implications of holding the shares, you may choose a sell-to-cover strategy. By selling a portion of the shares, you can generate cash to pay the taxes without holding onto the entire stock position.
  6. Estimate Quarterly Payments: If you anticipate a substantial tax liability from your RSUs, consider making quarterly estimated tax payments to avoid penalties and interest. Work with your tax professional to determine the appropriate estimated payment amounts and deadlines.
  7. Stay Informed about Tax Laws: Keep up to date with changes in tax laws that may affect your RSUs. Tax regulations can change over time, so it’s essential to stay informed and adjust your planning strategy accordingly.
  8. Diversify Your Investments: If you have a significant portion of your net worth tied up in RSU’s, consider diversifying your investments to reduce risk. Selling a portion of your vested RSU’s and reinvesting the proceeds in a diversified portfolio can help manage risk and potentially reduce the impact of a single stock’s volatility.

Avoid Being A Sitting Duck For The IRS Next April

If you consistently owe the IRS money at tax time, and especially if you have RSU grants, it probably means you should be setting up quarterly estimates to eliminate a nasty tax bill come April.

Remember, RSU taxation can be complex, and the specifics may vary depending on your individual circumstances. Consulting with a tax professional and financial advisor is crucial to ensure you’re following the most suitable strategy for your unique situation. They can help you make informed decisions that align with your financial objectives and minimize your taxes.

At WestStar we can introduce our clients to a CPA firm to ensure that their tax planning and preparation is in experienced hands, and gets the same level of care as their financial and investment planning does with us!

If you have questions about your specific circumstances, or want to talk further about what to do to best manage your RSU program, please get in touch. We welcome the opportunity to chat with you.

We wish you every success in the future and hope to hear from you soon.

Sam Gullette & Erik Alexander

Disclosures: “A diversified portfolio does not assure a profit or protect against loss in a declining market.”

“Asset allocation, which is driven by complex mathematical models, cannot eliminate the risk of fluctuating prices and uncertain returns.”

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.’