How Are My RSUs Taxed And How Should I Best Prepare?
In the dynamic world of tech employment, many compensation packages include restricted stock units (RSUs) as a significant component. RSUs can be a tremendously valuable asset, providing employees with ownership in their company and the potential for substantial financial gain. They are one of the greatest perks of these types of jobs. However, the tax implications of RSUs can be complex, especially for residents of California. Today, we'll dive a bit deeper into the taxation of RSUs, explore common issues faced by tech employees, and provide strategies for managing tax obligations effectively. This blog is very much an extension of previous posts, so if this situation applies to you, be sure to check them out as well!
Understanding RSU Taxation:
RSUs are treated as ordinary income upon vesting, meaning they are subject to taxation at your regular income tax rate. However, the main challenge arises from the difference between how RSUs are taxed and how they are withheld for tax purposes. While the IRS requires companies to withhold taxes at a rate of 22% on supplementary income, including RSUs, the actual tax liability may be higher, especially for high-income earners.
Tax Implications for Californians specifically:
For tech employees residing in California, additional considerations come into play due to the state's tax laws. California has one of the highest state income tax rates in the country, ranging from 1% to 13.3%. This means that RSU income is subject to both federal and state taxes, further complicating the tax picture for those living in the state. We highly recommend that anyone with RSUs consults their qualified tax professionals, including CPAs and financial advisors.
Common Tax Issues:
One of the most common issues faced by tech employees with RSUs is underwithholding. Because RSUs are taxed at ordinary income rates, the 22% required withholding rate for supplemental income under $1 million may not accurately reflect an individual's tax liability, especially for those in higher tax brackets. This discrepancy can result in a significant tax bill come April, potentially leading to penalties for underpayment of taxes. We like to emphasize this on an annual basis, to remind our readers not to fall into this situation and pay these unnecessary penalties.
Some Options for Managing RSU Taxes:
Fortunately, tech employees in California have several options for managing their RSU taxes to avoid underpayment and mitigate potential penalties…
Adjust Withholdings:
One option is to proactively adjust withholdings to ensure sufficient tax payments throughout the year. By contacting HR or the appropriate department within your company, you can request to adjust your withholdings to more closely align with your average tax bracket. This can be achieved in a few ways: 1) by setting your W4 to single with 0 exemptions, even if you are married and have children; 2) by adding an additional withholding to your ongoing paycheck; or 3) adjusting the withholding on the RSUs to your marginal tax rate. Any of these options would mitigate the risk that you have not withheld enough in taxes, and hopefully will be sufficient to cover your tax liability on RSU income.
Sell RSUs upon Vesting:
Another strategy is to sell a portion of your RSUs upon vesting to cover tax obligations. This approach allows you to proactively manage your tax liability and avoid surprises come tax time. By selling RSUs strategically, such as those that have not appreciated significantly or are at a loss, you can minimize tax implications while meeting your tax obligations. If this option is appealing, you should check whether your company has a 10b51 plan that can help you automate this process upon enrollment.
Wait Until Tax Time:
Alternatively, some tech employees may choose to wait until tax time to sell RSUs to meet their tax obligations. While this approach provides flexibility and the potential for increased investment returns if stock prices rise, it also carries risks, especially if the stock price declines. It's essential to consider liquidity and potential penalties for underpayment of taxes when opting for this strategy.
In conclusion…
Navigating the tax implications of RSUs can be complex, especially for tech employees in California. By understanding how RSUs are taxed, recognizing common tax issues, and implementing proactive strategies, you can effectively manage your tax obligations and maximize the benefits of your RSU compensation. Whether adjusting withholdings, selling RSUs strategically, or waiting until tax time, the key is to align your tax strategy with your overall financial goals and risk tolerance. By doing so, you can navigate tax season with confidence and financial empowerment. As always, we remind everyone to reach out to your tax professionals to optimize these decisions.
If you’re interested in learning more about how we think about stock compensation, below are a few other blog posts we’ve written over the years:
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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.