Your RSUs Were Withheld at 22 Percent. Your Tax Rate Wasn’t.

Restricted stock units frequently create an unpleasant surprise: taxes were withheld when the shares vested, but the employee still owes a substantial amount when the income-tax return is filed.

The problem is usually not that the RSUs escaped taxation. The problem is that the amount withheld may be considerably lower than the employee’s actual marginal tax rate. For a highly compensated employee, the difference can reach tens of thousands of dollars.

RSUs Are Generally Taxable When They Vest

A restricted stock unit represents an employer’s promise to deliver shares or their cash equivalent after specified vesting requirements are satisfied. Unlike certain restricted-stock awards, RSUs generally are not taxable when granted. The taxable event commonly occurs when the units vest and the shares are delivered.

The fair market value of the vested shares is generally treated as compensation and included on the employee’s Form W-2. The income is subject to federal income tax and applicable payroll taxes.

For example, assume an executive receives 4,000 shares when the company’s stock is worth $75 per share. The vesting event creates $300,000 of compensation income: 4,000 shares multiplied by $75.

The executive may not receive $300,000 in cash. The employer may retain or sell a portion of the shares to cover withholding. Seeing fewer shares delivered can create the impression that the tax obligation has been fully satisfied. That is not necessarily true.

Why 22 Percent Withholding Can Be Misleading

Employers may treat RSU income as supplemental wages. Under the federal supplemental-wage withholding rules, an employer may, when the applicable requirements are met, withhold federal income tax at a flat 22% rate on supplemental wages up to the relevant threshold.

The mandatory rate on supplemental wages exceeding $1 million during the calendar year is generally 37%. The detailed rules and available withholding methods are discussed in the IRS’s current Publication 15.

The withholding rate is not necessarily the employee’s ultimate income-tax rate.

Suppose an executive has $350,000 of salary and bonus income, a $300,000 RSU vest, married-filing-jointly status, a spouse with additional compensation, and federal withholding on the RSUs at 22%.

The employer might withhold $66,000 of federal income tax from the RSU vest. But some or all of that income may fall within a higher marginal federal bracket when the couple’s complete return is prepared.

If the relevant income were ultimately taxed at a marginal rate of 35%, the difference between a 35% rate and 22% withholding would be $39,000. This simplified illustration is not a calculation of the couple’s actual liability. It demonstrates the central problem: withholding is merely a prepayment. It is not a determination of the tax ultimately owed.

Multiple Vesting Dates Can Hide the Problem

Many executives receive RSUs that vest quarterly, monthly, or on several dates throughout the year. A single vest may not appear alarming, but the combined annual value can be significant.

Consider an employee with four quarterly vests: $75,000 in March, $90,000 in June, $110,000 in September, and $125,000 in December. The employee has received $400,000 of additional compensation during the year.

The cumulative amount may affect federal brackets, state income taxes, estimated-tax requirements, Additional Medicare Tax, income-sensitive deductions and credits, and the consequences of selling retained shares. A December vest is particularly important because little time may remain to address an underpayment before year-end.

Bonuses and Stock Compensation Compound the Exposure

RSU recipients frequently receive annual bonuses, performance compensation, nonqualified stock options, employee stock purchase plan shares, retention payments, deferred compensation, or capital gains from selling employer stock.

Each item may appear adequately withheld when viewed independently. Collectively, they may push the employee into a higher marginal bracket and create a significant payment obligation. The risk is even greater in a dual-income household where both spouses receive bonuses or equity compensation.

Payroll departments generally withhold according to standardized rules. They do not prepare a joint household tax projection incorporating the spouse’s income, investments, business income, capital gains, deductions, or estimated payments.

Selling Shares Does Not Eliminate the Vesting Income

Another common misunderstanding is that selling RSU shares immediately after vesting somehow avoids the taxable compensation. The vesting income has generally already occurred. Selling the shares creates a separate transaction.

Assume an employee receives 1,000 shares at vesting when the stock is worth $80. The employee generally has $80,000 of compensation income and an $80-per-share tax basis.

If the shares are later sold for $86, the additional $6 per share may create a capital gain. If they are sold for $72, the employee may have a capital loss. Selling immediately can reduce exposure to later price changes, but it does not reverse the original compensation income.

State Taxes Create Another Layer of Risk

Employees who live or work in more than one state may face additional complexity. RSU income may need to be allocated based on where the employee performed services during the applicable grant-to-vest period.

This becomes especially important when an employee relocates, works remotely from another state, transfers between offices, or moves shortly before a large vest. Changing residency before vesting does not necessarily eliminate the former state’s potential claim to the income.

Common RSU Tax Mistakes

• Assuming shares withheld for taxes fully satisfy the liability
• Confusing the withholding rate with the final tax rate
• Forgetting to include a spouse’s income in the projection
• Ignoring future vesting dates or a large annual bonus
• Treating each vest as an isolated event
• Overlooking state sourcing after a move
• Selling shares without preserving vest-date information
• Failing to review the basis reported by the brokerage firm
• Waiting until tax-return preparation to discover the shortfall

The Tax Projection Should Come Before the Surprise

An equity-compensation projection should consider the complete household tax picture, including expected salary, bonuses, RSU vesting, stock sales, investment income, deductions, withholding, estimated payments, and state residency.

At Zagmout & Company CPAs, we work with executives and other highly compensated employees to evaluate the tax consequences of RSU vesting and related stock transactions. This may include projecting the annual liability, reviewing withholding, assessing estimated-payment exposure, and coordinating the information required for accurate tax-return reporting.

Disclaimer: This article is for general informational purposes only and does not constitute accounting, tax, legal, financial, or investment advice. The application of these matters depends on individual circumstances and should be evaluated with qualified professional advisers.