In this article, we will tell you everything you need to know about how Restricted Stock Units (RSUs) are taxed. Plus, we’ll cover four strategies to consider with your RSU compensation to reduce your tax bill. If you’re a Tech employee, we also recommend you check out our Guide to RSUs.
Restricted Stock Units (RSUs) are a popular type of compensation for those employed in the Tech industry.
In some cases, like for Amazon employees, the RSU portion of compensation can make up over half of their total annual pay. Therefore, understanding how they work, how and when taxes are paid, and potentially reducing your tax bill is critical to optimizing this employee benefit and accelerating your progress towards your financial goals.
You Will Learn:
- How RSUs work
- How RSUs are taxed
- RSU Tax Strategy: 4 Ways to Reduce Your Tax Bill
- FAQ’s: Common Restricted Stock Unit Questions
How RSUs Work
Restricted Stock Units are a popular form of stock compensation that, compared to other forms of equity compensation, are relatively straightforward once a few key components are defined:
- Grant Date: On this date, your company promises a specific number of “restricted“ shares to you, the employee. These shares are earned over a vesting period, which is typically over a period of months or years but could also be tied to specific performance objectives.
- Vesting Date: The date on when the shares officially become yours (a.k.a., they are no longer “restricted“). A typical vesting schedule is where 25% of the shares vest per year over four years.
- RSU Taxes: RSU compensation is taxed as ordinary income when the shares vest and based on your shares’ value on the vesting date. Think of them like a cash bonus that’s linked to the price of your company’s stock. If you hold the shares for a year or longer after vesting, any gain (or loss) is taxed as long-term capital gains (shares held less than one year from vesting are taxed at short-term capital gains tax rates).
Here’s an example of how this works in practice.
- 4,000 RSU shares granted in June 2020
- 25% of these shares (1,000) vest in June of 2021
- The share price is $50 on the vesting date (this becomes your cost basis if holding the shares)
- You owe taxes on $50,000 of RSU income for 2021. Assuming a 35% Federal tax rate means your total tax bill on these shares is $17,500.
- Then, if the shares are held for a year and then sold for $80 per share, you will pay taxes on a $30,000 capital gain ($80 – $50 x 1,000 shares). At the 15% capital gain tax rate, this means another $4,500 of taxes in addition to the $17,500 of ordinary income.
For more on how RSUs work, how to periodically manage your company stock to prevent concentration risk and income/career risk and, if you are an executive or insider, how to follow company and SEC guidelines when buying/selling company stock, I recommend starting with our post A Tech Employee’s Guide to RSUs.
How RSUs Are Taxed
Compared to other forms of equity compensation, the tax treatment of RSUs is pretty straightforward. However, it’s still important to understand and manage it appropriately.
RSUs are taxed as income to you when they vest. If you sell your shares immediately, there is no capital gain tax, and the only tax you owe is on the income. However, if the shares are held beyond the vesting date, any gain (or loss) is taxed as a capital gain (or loss).
The tax treatment of RSUs is no different than if you were to receive a cash bonus (on the vesting date) and then use that cash to buy your company’s stock.
- Tax at vesting date is: # of shares vesting x price of shares = Income taxed in the current year
- Tax when shares are sold (if held beyond vesting date) is: (Sales price – price at vesting) x # of shares = Capital gain (or loss)
For 2021, income taxes rates are as follows:
|Federal Income Tax
(Married, filling jointly)
|10%||$0 to $19,900||$0 to $9,950|
|12%||$19,901 to $81,050||$9,951 to $40,525|
|22%||$81,051 to $172,750||$40,526 to $86,375|
|24%||$172,751 to $329,850||$86,376 to $164,925|
|32%||$329,851 to $418,850||$164,926 to $209,425|
|35%||$418,851 to $628,300||$209,426 to $523,600|
|37%||$628,301 or more||$523,601 or more|
And 2021 long-term capital gains tax rates are as follows (short-term gains are taxed according to income tax rates):
|Long-Term Capital Gains
(Married, filling jointly)
|0%||$0 to $80,000||$0 to $40,400|
|15%||$80,001 to $501,600||$40,401 to $445,850|
|20%||$501,601 or more||$445,851 or more|
What about tax withholding on my RSU income?
Most companies don’t withhold taxes according to your W-4 rate but will instead use the flat IRS rate for supplemental wage income. For 2021, that rate is 22% on supplemental wages up to $1 million and 37% for wages in excess of $1 million.
Please note that if your RSU income is taxed above 22% when your taxes are filed, depending on your other tax withholdings, you may owe additional taxes when you file. You may consider withholding additional federal taxes from your paycheck or setting aside money to cover your tax bill at year-end if you anticipate that you will be in this situation.
Now that we’ve reviewed how RSUs work and how they are taxed let’s examine four tax strategies to reduce your tax bill.
RSU Tax Strategy – 4 Ways To Reduce Your Tax Bill
1. Using RSUs to MAXIMIZE Tax-Deferred Contributions
Contributing to your employer-sponsored 401(k) account or an individual retirement account (IRA) comes with a tax benefit, as a contribution to these accounts reduces your taxable income in the current year. But an additional planning opportunity exists for anyone who is holding vested RSUs but not maxing out these accounts due to cash flow constraints.
If you are holding RSUs to delay paying taxes on the gains, the proceeds from the sale can be used to max out tax-deferred accounts and offset your tax bill (in addition to diversifying your investment portfolio).
The maximum employer 401(k) contribution for 2021 is $19,500 with an additional $6,500 catch-up contribution for those turning 50 or older in 2021. And the maximum IRA contribution is $6,000 with a $1,000 catch-up contribution available.
Let’s look at an example.
Marcia has 2,000 vested RSUs worth $10/share and a cost basis of $5/share. She has held the shares for more than two years and is contributing $10k of the allowable $19,500 in her employer 401(k) plans. She is not contributing to an IRA account.
Additionally, her income places her in the 15% and 24% tax brackets for capital gains and income, respectively.
In this scenario, Marcia could sell her 2,000 shares for $20k, creating a capital gains tax liability of $1,500 ($5 gain x 2,000 shares x 15% tax rate). Then she could use the first $9,500 of the proceeds to max out her 401(k) account—netting a tax reduction of $2,280 ($9,500 x 24%). With the remaining money, she could contribute up to $6k to a traditional IRA account and reduce her tax bill by up to another $1,440 ($6,000 x 24%)—subject to phaseouts based on income.
Here’s what this looks like:
All in, this strategy could save Marcia up to $2,220 ($3,720 saved – $1,500 in capital gains tax) in taxes in the current year while allowing her to diversify her investment portfolio and save money in a tax-advantaged account.
Now, for those of you already maxing out your retirement accounts, the next strategy might be for you.
2. Deduction Bunching
With the increase of the standard deduction to $24,800 for couples and $12,400 for individuals as part of the 2017 Tax Cuts and Jobs Act, deduction bunching becomes that much more important for anyone looking to itemize deductions as part of their tax returns.
Essentially, deduction bunching is squeezing as many deductions as possible into one tax year in order to boost itemized deductions above the standard amount and therefore minimize taxes in that year.
Because RSUs are taxed as income in the year they vest, if you have a large tranche of RSUs vesting in any given year, you should consider bunching deductions to offset some of this income.
The most common itemized deductions are:
- Mortgage Interest
- Charitable donations
- Medical expenses
- And State and Local taxes (known as SALT deductions) including real estate taxes
Because SALT deductions, for now, remain capped at $10k and mortgage interest doesn’t lend itself to bunching, the opportunities here are with mainly with charitable donations and possibly with medical expenses.
Medical expense deductions, starting in 2020, are limited to the “total qualified unreimbursed medical care expenses that exceed 10% of your adjusted gross income.” If you have a year with high medical expenses pushing you over the 10% threshold, the opportunity exists to prepay any upcoming costs and to pull as much of the deduction into the current year as possible.
For example, if your kid is due for braces, your orthodontist may allow for payments to be spread out over a couple of years. But, if you are over the 10% AGI threshold and can swing it from a cash flow perspective, you should consider paying the full cost upfront in order to bunch the expenses and pull the tax benefit into the current year.
Charitable giving is the same. If you are charitable and can afford to, in a high-income year driven by RSUs, you can pull five years of giving forward into the current year in order to bunch deductions and further reduce your tax bill. (In the next section, we will look at a popular vehicle to make this process easier.)
A side-by-side comparison of how this would look is below. In this scenario, we compare the standard deduction (without bunching) to itemized deductions with bunching. We assume an extra $2k in medical expenses, which are deductible and bunching five years of charitable contributions at $5k per year.
The bunching strategy results in an additional tax deduction of $20,200 in the current year with no reduction in subsequent years (since you will use the Standard Deduction) and saves you nearly $4,500 on your tax bill today.
3. Donor Advised Funds
Let’s say you have the ability to pull five years of charitable giving forward, as in our example above. But, like many people, you would still prefer to give the funds over the five years while getting the tax deduction. How can you achieve this? Enter the donor-advised fund (DAF).
We’ve written before about utilizing a DAF, but quickly recapping the key steps:
- Open a Charitable fund in your name
- Contributions to the fund are deductible in the year received
- Assets can be invested and grow tax-free
- Grants can be made to charities at any time in the future
What’s more, highly appreciated securities can be used to fund a DAF—not only scoring a tax deduction in the funding year but also avoiding capital gains tax on the donated securities.
Essentially, utilizing a DAF allows the charitable bunching strategy combined with the capability to give as you typically would. The only downside is that you must have the ability to fund the account upfront, and the donation is irreversible. Once you’ve funded a DAF, the money must be given to charity.
4. Defer Taxes by Hedging With Options
While our first three strategies covered reducing your tax bill today, our last planning strategy explores a way to hedge your RSU position and delay the sale—either because you need to maintain a position in your company stock or to delay the tax bill to a potentially more favorable year.
A quick caveat—options can be risky and should be fully understood before implementing any strategy. Additionally, like with anything, there is no free lunch. Hedging a position, even if generating income in the process, comes with tradeoffs.
Let’s look at a couple of the most common strategies: The covered call and the collar.
Under this strategy, call options are sold above the current price (called out of the money). This generates income but caps your potential for gain with essentially all the risk of loss remaining.
In the scenario below, using Intel’s stock from February of 2020, we depict this strategy of selling $70 calls that expire in January 2021. This brings in a premium of ~7% but caps your maximum gain on the position at 13%—at a price of $70 per share or higher. However, as you can see, the downside is essentially uncapped save for the 7% premium generated.
The tradeoff for generating this premium income is capping your return at 13% and still taking the downside of the stock. However, if the stock price doesn’t move over the next year, you have generated a nice healthy income stream over the period.
Unlike the covered call strategy, a collar strategy does hedge the downside by buying a put. However, instead of just buying a put (which is expensive), a call is also sold to offset some or all of the costs.
In our example below, selling January 2021 calls and buying puts on Intel stock leads to a premium income of 1.4%. The tradeoff is minimal income and a narrow range of potential outcomes.
Either of these strategies could be right for your given situation, but the point is they aren’t without risks and tradeoffs. However, they could help you defer the sale of your RSUs until a more favorable time.
RSU FAQs: Common Restricted Stock Unit Questions
What is an RSU Offset?
RSU stock income is reported on your pay stub after vesting. The RSU Offset may be shown in the deduction line since you don’t receive cash in your pay at vesting but instead in your brokerage account when the shares are sold.
Are RSUs taxed twice?
No. The value of your shares at vesting is taxed as income, and anything above this amount, if you continue to hold the shares, is taxed at capital gains. The second taxable event (the capital gains tax) doesn’t apply to any portion you have already paid income tax on.
At what tax rate are RSUs taxed?
RSUs compensation is taxed at your ordinary income tax rate. If you choose to hold your shares after they vest, any gain (or loss) is taxed as a capital gain (or loss).
When is RSU income taxed?
RSU income is taxed when your shares vest. Your employer will typically withhold taxes at the federal supplemental wages withholding rate, which is 22% up to $1 million of income and 37% for wages in excess of $1 million.
Is RSU income included on your W2?
Yes. At vesting, RSU income is reported on your W2, and any taxes withheld are included as well.
Are RSUs better than Stock Options?
RSUs are like options with a $0 strike price. So, a RSU share is always at least as valuable as one stock option. However, because of this, companies typically grant more shares of options than RSUs. A rule of thumb for Technology employees is that four Options are roughly equivalent to one RSU share.
Your RSU Strategy Is Critical To Your Financial Success
As financial advisors, our job at Cordant is to accelerate our clients’ progress toward their definition of financial success.
And optimizing your RSU strategy is one way to do just that.
Whether you work with an advisor or not, make sure you understand and plan how you can make the most of this important form of compensation for those working the technology industry.
And, if we can be of any help, please get in touch. We’ll start with a short 15-minute call to talk about your situation, goals, and concerns to see if it merits discussing further how we can help.