If you receive RSUs (Restricted Stock Units) as compensation, you've probably wondered why it feels like you are being taxed twice. Some common characteristics include:
- Having a large tax bill each year
- Recognizing ordinary income and capital gains
- Reporting zero cost basis when you file your taxes
Depending on your experience with equity compensation and the Internal Revenue Code, a few wrong moves can significantly increase your tax bill and might even generate additional penalties and interest.
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Here are some ways to avoid paying extra taxes on your RSUs:
Increase Your Tax Payments
When you receive an RSU vest, annual bonus, or sales commission, this is known as supplemental income. The IRS and your state tax agency have published set withholding percentages that your employer must withhold taxes at. For Federal withholdings, you typically will owe 22% for Federal taxes, 6.2% for Social Security taxes, and 1.45% for Medicare taxes. You can find your state's supplemental withholding rate here.
This is usually not enough to cover your tax liability. For example, if your income is over $165,000 for singles or $330,000 for married couples, every additional dollar you earn will be taxed at 32%. The more RSUs that vest, the larger your tax bill becomes. To help avoid this, you can increase your normal payroll withholdings or make quarterly estimated tax payments.
Sell Your RSUs Immediately
When your RSUs vest, the Fair Market Value of the shares is included on your paystub and W-2. Since you were given shares of stock that are subject to the stock market, the value can continue to rise (or fall). If you don't sell your shares right away, you could also be subject to capital gains taxes. Depending on your income, you could also owe an additional 3.8% in Net Investment Income Taxes.
The standard analogy from financial planners has been, "if you were to receive a large cash bonus from your employer, would you turn around and invest all of it in your company's stock?" From this perspective, most would answer no. Selling your RSUs right away can limit your taxes and avoid any potential losses in value.
Work With A Tax Professional
After all is said and done, you will receive your tax documents at the end of the year. For people with RSUs, this usually looks like a W-2 and a 1099. Your W-2 will include the Fair Market Value of stock received (reported as income) and your 1099 will report your stock sales (reported as capital gains). Seems straightforward - right?
When you go to enter your information into your tax software, you notice that your cost basis (purchase price) for your RSUs is zero. This is because you didn't actually purchase the shares, but they were awarded to you. If you report it as-is, you will be paying tax twice. To avoid this common error, an adjustment needs to be made to your cost basis in order to properly capture the income already reported on your W-2. An experienced tax professional can ensure that your RSUs are reported correctly so that you are not "taxed twice".
Understanding how your equity compensation is received, reported, and taxed is important to make sure you aren't taxed twice. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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This article first appeared on the Amaral Financial Planning blog at https://amaralfp.com/2022/04/25/how-to-avoid-being-taxed-twice-on-your-rsus/
Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.
