If you work in tech, RSUs may be a large part of your pay. When they vest, the full market value of the shares is added to your W-2 as ordinary income. Your employer withholds tax, usually by selling some of the shares. The problem is how much they withhold.
The 22% problem
Employers can treat RSU income as supplemental wages and withhold federal tax at a flat 22% on the first $1 million of supplemental wages in a year. Above $1 million, the mandatory rate is 37%.
If your household income puts you in the 32%, 35% or 37% bracket, a 22% withholding rate leaves a gap of 10 to 15 cents on every dollar that vests. On $300,000 of vesting stock, that's a shortfall of $30,000 to $45,000, before state tax.
Why it matters beyond the April bill
A large balance due isn't just a cash-flow surprise. If total withholding and estimated payments fall short of the safe harbor, you can owe an underpayment penalty too. To stay safe, most taxpayers need to pay in at least 100% of last year's tax, or 110% if last year's adjusted gross income was over $150,000, or 90% of this year's tax.
How to close the gap
- Run a projection. Estimate this year's total vesting, bonuses and other income, then compare the tax with what has been withheld so far.
- Adjust your W-4. Extra withholding from regular paychecks counts as if it were paid evenly through the year, which helps with penalties even late in the year.
- Ask about a higher RSU rate. Some employers let you elect a higher withholding rate on vests.
- Make estimated payments. Quarterly federal and state estimates can cover the difference.
- Set aside cash at each vest. If you keep the shares, set aside the expected shortfall in cash so it's ready when the bill arrives.
The cost basis trap
When you later sell RSU shares, your broker issues a Form 1099-B. Brokers often report the cost basis as zero or leave it out. If the return is filed with that number, you pay tax on the same income twice: once as wages on your W-2 and again as a capital gain.
The fix is to report the correct basis, which is the value of the shares at vest, already included in your W-2, using the supplemental information from your stock plan provider. It's one of the most common errors we correct on returns that come to us.
Hold or sell?
From a tax standpoint, holding vested RSUs is the same as receiving a cash bonus and buying company stock with it. Many people hold more of their employer's stock than they would ever choose to buy. Selling at vest locks in a basis equal to the value already taxed and helps you diversify. If you hold, gains are short-term for the first year after vest and long-term after that. Washington residents should also keep the state's capital gains tax in mind on large long-term gains.
The bottom line
RSUs are wages, and high earners usually need to pay more than the default withholding. A mid-year projection and a few minutes adjusting your W-4 or estimates can save you a large April bill and a penalty.
This article is general information, not tax, legal or investment advice for your situation. Rules and thresholds change, so please talk with a qualified advisor before acting.
