Handling Unexpected Tax Bills From RSUs

Employers are always on the lookout for better ways to compensate their employees. Paying employees in stock instead of cash has the appeal of being more affordable in the short term while also incentivizing employees to commit to long-term employment and improving their employer’s financial performance.

Stock options were a popular way to provide compensation that achieved these goals. But after relatively recent accounting scandals and the risk of a bear market, restricted stock units (RSUs), have become a more popular form of stock-based compensation. With many employers shifting their equity compensation packages from stock options to RSUs, there come slightly different tax implications for the employee. 

Let’s take a look at what these are and what to do if you receive a large and unexpected tax bill because you were compensated with RSUs. 

What Are Restricted Stock Units?

Restricted stock units refer to a form of compensation where the employer promises to give the worker (usually an employee) shares of stock after certain conditions have been met. It’s up to the employer to decide what these conditions are, but they usually relate to the employee staying with the employer for a certain amount of time and/or meeting specific performance benchmarks.

The employer gives these RSUs to the employee in accordance with a vesting schedule or plan. The employer can typically create almost any plan they want, but the RSU distribution schedule will often span several years. The RSUs may vest over time or all at once at the end of the plan.

There are two key dates when it comes to RSUs. The first is the grant date, which is the date the employee receives the RSU. At this time, the employee receives no shares of stock or anything of tangible value. Rather, they receive the RSU, which identifies how many stocks the employee receives on the vesting date. There is no taxable event at this point.

The second is the vesting date, which is the date the employee actually receives the shares of stock. The value of the compensation the employee receives will be the number of shares multiplied by the fair market value of the shares on the date of vesting. When the RSUs vest, the employee can choose to hold on to the shares or immediately sell them. Either option will result in a taxable event. 

How Are My RSUs Taxed? 

The answer to this question depends on what you do with the shares after they vest and how much (if any) your employer withholds for taxes. Generally speaking, the date your RSU vests, the fair market value of the stocks you obtain will be considered ordinary income for individual income tax purposes. This means that the value of the shares will be income included on your W-2 and the amount of taxes you pay is based on your ordinary tax rate and not the capital gains rate.

Because the vesting of the RSUs results in taxable ordinary income, payroll taxes, such as FICA taxes, are also due. Employers will usually withhold these taxes (in addition to the taxes withheld for income tax purposes) when they disburse shares as required by the RSUs. Typically, employers cover the taxes by selling some of the shares that you should have received and using those amounts for the taxes. This is called the sell-to-cover strategy. However, employers can also let employees pay the taxes out of pocket.

If your employer doesn’t withhold the necessary taxes when they issue you the shares in accordance with the RSU plan, you’ll have to make sure you pay these taxes yourself. If your employer doesn’t make it clear that they have withheld any (or enough) taxes, it’s easy to miss this requirement and find yourself facing an unexpected tax bill when you prepare your income tax return.

You might also have to pay additional taxes in the form of capital gains taxes if you decide to sell your shares at a later time and they have gone up in value. Your capital gains tax rate will depend on how long you hold onto the shares before selling them.

If you sell them more than a year after receipt, then you’ll pay the long-term capital gains tax, which will be 0%, 15%, or 20%, depending on your tax situation. If you sell the shares within a year of receipt, then you pay the short-term capital gains tax which is equal to your ordinary income tax rate (this would be the same rate that applied when your RSUs vested). 

How to Manage RSU Tax Liability 

The best way to deal with your tax obligations stemming from RSUs is to be proactive about understanding your tax liabilities. This means making sure your employer withholds the correct amount of money when issuing you the stock shares. If they don’t, you’ll need to calculate how much you owe and make the estimated quarterly tax payment yourself.

Another option to help deal with the tax implications of your RSUs is to negotiate with your employer as to when you receive your stock shares after they vest. In some cases, this can delay when you have to pay income taxes on this stock award.

For example, pretend you earned $200,000 in regular wages this year along with another $50,000 in vested RSUs. This year you have $250,000 in ordinary income subject to income tax. But what if you knew that next year, your regular wages would be much lower, perhaps due to you retiring? It would be in your interest to shift that $50,000 in the stock award to next year when your income would be lower and you would likely have a lower ordinary income tax rate.

Keep in mind that any negotiations that benefit you might be a detriment to your employer. For instance, if you delay when you actually receive your stocks, it may also delay when your employer can take the tax deduction for your compensation. Therefore, don’t be too surprised if your employer doesn’t want to negotiate or is only willing to provide a very short delay as to when you receive your stock shares.

Whichever approach or strategy you choose, it can help to talk with a tax pro about your tax liability and how to reduce it. Ideally, you should do this when your employer grants you the RSUs and not when they vest.

What to Do If You Can’t Pay Your Taxes From Your RSUs 

One of the biggest issues with RSUs is that they can result in a surprise tax bill. The size of this bill depends on the size of the stock award and how deficient the employer’s withholding is. If you’re an employee with generous RSU compensation, this could result in tens of thousands of dollars you owe the IRS for unpaid taxes and penalties.

In a best-case scenario, this is an annoying surprise that you can quickly (although begrudgingly) pay. In a worst-case scenario, you have a tax balance that you can’t possibly hope to pay off in the near future.

In this latter situation, you’ll have to find a plan to pay off your tax balance over time or reduce how much you owe. Some of these options you can sometimes set up yourself, like a payment plan. Other options are more complex and might benefit from the services of a tax attorney. These can include an offer in compromise and requesting Currently Not Collectible status. 

Get Help With Your Restricted Stock Unit Tax Bill

Receiving RSUs is a good thing, but if you’re not prepared for the tax implications of stock compensation, you could be in for a rude awakening with an unexpected tax bill. The best course of action is to talk to a tax attorney before your RSUs vest so you can anticipate your incoming tax obligations. 

But even if you’re at a point where you’ve already cashed out your RSUs and now have a tax bill you can’t pay right now, Seattle Legal Services, PLLC can still help you find a way to pay your taxes over time. We offer free consultations and you can contact us by phone at 425-428-5262 or through our online contact form.