If you work for a large company, especially in tech, there is a good chance part of your compensation comes in the form of RSUs, or Restricted Stock Units. Think of them as a gift with a string attached: your company grants you shares of stock, but you cannot touch them right away.
The shares are released and made available to you over time in a process called vesting. Once the shares vest, you can hold them as a long-term investment or sell them right away for liquidity or to reduce risk. Either way, here is the part that catches people off guard.
The Moment Your Shares Vest, the IRS Is Already Watching
The moment your shares vest, the IRS treats them as ordinary income, the same as a paycheck. If 100 shares vest when the stock is trading at $250, you have $25,000 of taxable income that day, and it shows up on your W-2 at the end of the year.
To handle the taxes, most companies use a sell-to-cover arrangement. Before the shares ever hit your brokerage account, the company automatically sells a portion of them and sends the proceeds to the IRS on your behalf, similar to how federal taxes are withheld from your paycheck. You never see those shares; they are sold and the proceeds go straight to Uncle Sam.
The Problem: 22% Is Often Not Enough
The default withholding rate on RSUs is 22%. For many high earners, that falls well short of what they actually owe.
Example: Matt is a single filer with $600,000 in salary. He also receives 100 shares of company stock per quarter. When his 100 shares vest at the end of March at $250 per share, his company sells about 30 shares1 to cover federal tax at 22%, Colorado state income tax, Medicare, and Social Security.
Assuming the same happens each quarter, Matt's W-2 at year-end shows $700,000 in total wages: $600,000 in salary plus $100,000 from his RSUs. That puts him firmly in the 37% marginal tax bracket.
His employer withheld $22,000 to cover federal taxes on that $100,000 in RSU income. The actual federal tax owed on it is roughly $35,900. That is a $14,000 shortfall on federal tax alone, before accounting for any state tax gap. When Matt files, he will owe a significant amount, and depending on how far short he came up, he may owe IRS underpayment penalties on top of that.
Stock Price Swings Make It Worse
The tricky part is that nobody knows what their shares will be worth when they vest. A stock price that jumps at the wrong time can push you into a much higher bracket than you were expecting. That is why anyone receiving RSUs should work with a tax professional each year to estimate whether they owe quarterly estimated payments to cover the gap before the bill comes due.
What to Do About It
The right strategy depends on your total income, filing status, other withholding sources, and when your shares vest throughout the year. There is no single formula that works for everyone.
What you can do is get ahead of it. At Balanced Wealth Partners, we work with clients receiving equity compensation to calculate a tentative tax liability and determine a safe harbor2 number to avoid underpayment penalties to the IRS.
If you receive RSUs and are not sure whether your withholding is keeping up, that is exactly the kind of question we can help you answer before April.
1 Average withholding through all four quarters would be 30.25 shares: 34 shares in Q1 due to Social Security withholding, and 29 each quarter thereafter once Social Security is maxed out.
2 Safe harbor is the IRS term for the minimum amount of tax that must be paid to avoid underpayment penalties. Meeting safe harbor does not eliminate what you owe; it protects you from penalties while you settle the balance at filing.
Disclosures: This article is for educational purposes only and does not constitute tax, investment, or legal advice. The example above uses simplified assumptions for illustration purposes; actual tax liability depends on individual circumstances including filing status, total income, deductions, and applicable state taxes. RSU tax treatment is subject to IRS rules and may change. Consult a qualified tax professional before making decisions related to equity compensation. Balanced Wealth Partners is a registered investment advisor in Colorado.