Restricted Stock Units (RSUs) are one of the most common forms of equity compensation in the tech world. They can be a fantastic way to build wealth, but they’re also a tax trap if you don’t know the rules. Every year employees lose thousands of dollars simply because no one explained how RSUs are taxed.
Here are three of the most costly mistakes to avoid:
1. Selling All Shares Immediately Without Understanding Withholding
When RSUs vest, the fair market value of the shares is treated as ordinary income, just like a bonus. Companies typically sell a portion of the shares to cover withholding taxes. The problem? That withholding rate is often too low (commonly 22% for federal tax).
For higher earners, your real tax rate may be 32%, 35%, or more. If you sell all your shares right away, you may still be left with a surprise tax bill in April because the default withholding didn’t cover your true liability.
Tip: Always check your marginal tax rate and consider setting aside additional cash for taxes, especially if your company uses the flat 22% withholding.
2. Forgetting That RSUs and ESPPs Are Taxed Differently
RSUs and Employee Stock Purchase Plans (ESPPs) often get lumped together in people’s minds, but the IRS treats them very differently.
- RSUs are taxed as ordinary income when they vest.
- ESPP shares may qualify for capital gains treatment if you meet the holding period rules.
Mixing up the two can lead to overpaying or underpaying taxes, both of which cause problems later.
Tip: Always separate your RSU strategy from your ESPP strategy. They’re different tools with different tax outcomes.
3. Not Planning Ahead for the Tax Bill
RSUs feel simple because the company handles the vesting and the sale of shares. But behind the scenes, things can get complicated fast:
- The shares withheld for taxes may not cover the full liability.
- Additional income from bonuses, stock options, or ESPP gains can push you into a higher bracket.
- If you live or move across states, multi-state taxation can make the calculations even trickier.
Without planning, you might find yourself short on cash at filing time.
Tip: Use tax projections during the year to estimate what you’ll owe. If you’ve had multiple vesting events, don’t wait until April, adjust your withholding or make estimated payments to stay ahead.
The Bottom Line
RSUs can be a powerful way to grow your wealth, but they come with tax complexity that many employees aren’t prepared for. The three mistakes above (assuming withholding is enough, confusing RSUs with ESPPs, and failing to plan for the bill), are all preventable with a little proactive tax planning.
Working with a CPA who understands equity compensation can help you avoid surprises and keep more of what you’ve earned.
At Wise.CPA, I help clients with RSUs, ESPPs, and stock options create strategies that fit their financial goals and eliminate tax season stress.