The UGLY TRUTH about RSUs
There are 3 ugly truths that no one has told you about your RSUs. The worst part is, these things happen outside of your control and are set up as the default, yet you’re left to pay the bill. If you’re passive with your RSUs, just letting them vest, or if you skip this info, it’ll triple your trouble. So let me show you the 3 easy steps on how to fix it, save on taxes, and optimize your RSUs. Because not even your CPA will tell you the truth until it’s too late.
TRUTH 1: Tax Surprise
Here’s the first mistake that your company sets up by default—which is quite ironic because Restricted Stock Units are meant to be a benefit from your company, but this one in particular causes a lot of surprise tax bills that can force you to empty your bank account. I would hope that your employer would tell you about this potential trap because I’ve seen this time and time again.
When your RSU’s vest, you owe ordinary income tax on the fair market value on the day of vest. Behind the scenes, your company will actually withhold the tax for you. But when you meet with your CPA, they’ll say you owe more taxes. Why? Because your company only withholds taxes at 22% as a default…unless you’re earning more than a million dollars per year at which point they’ll withhold at 37%. Companies generally default to 1-2 withholding tax rates when there are actually 7 different possible outcomes. The problem, is where your actual tax bracket is, let’s say 35%, but your company only withholds at 22%. Behind the scenes, your company under withheld by 13%. So you meet with your CPA and they’ll tell you this after you discover the surprise tax amount. Therein lies the problem. By then it’s too late. CPAs are reactive and tell you how much you owe. Tax planners are proactive and tell you how to owe less. If you’d like to owe less in taxes and optimize your investments, you can work with Tech Wealth using the link below. No tax surprises, just tax savings.
So what can you do to avoid the withholding problem?
Remember, this needs to be done in advance, otherwise you may be on the hook if you don’t do this soon enough. You’ll want to reach out to your company’s HR department and ensure that their withholdings match your tax bracket for the year. Don’t forget about other types of equity that may increase your income beyond just your salary (such as NSOs) to get a more accurate withholding.
But if you think a surprise 13% tax bill is bad, then you should see how much in taxes some people pay from this next RSU mistake.
TRUTH 2: Double-Trouble Tax
Let me show you these numbers….Which number do you think is the highest tax rate some people pay on their RSUs? 37%, 50%, or 86%? Well it’s the larger of the 3. Let’s say you had $300k of RSUs that you sell immediately upon vest. You wouldn’t have $300k hitting your bank, you’d only have $42k hitting your bank. Let that sink in. You’d have $258k going to the IRS and state tax. (37% Federal Income tax, 37% short term capital gains, and 12% state tax in this example of state tax). This isn’t some temporary surprise like forgetting to update your withholdings, this could be permanent if not caught or corrected. It’s also something that your CPA might not even catch, and you probably won’t catch plugging into TurboTax by yourself.
When your RSU’s vest, the fair market value on the date of vest will be reported on your w2 through your employer plus any withholdings. You pay tax on that FMV, raising your basis, which is all correct and good up to this point. Now, this next thing is where the problem exists—the problem of double taxation. When the broker holding your RSUs reports the sale of your RSUs and says you have no basis—it effectively causes you to be taxed on it twice when you sell. Here’s how to fix it…
What you’ll want to do is grab the tax form 1099-B, which reports the proceeds from the sale. You’ll receive this from your broker. When you grab your 1099-B, you want to double check the column titled, “Cost or Other Basis.” If the number in this column is zero, then there’s a good chance you’re being double taxed. You’ll need to take the supplemental form which is usually accompanied with the 1099-B and ensure that you adjust the cost basis. There’s a column titled “adjusted basis” where you’ll need to include the fair market value on the vesting date of the shares that you sold.
While taxes may seem bad, they’re actually based on a percentage of the actual value and this next truth, can negatively affect your physical net worth…not just a percentage of it.
Truth 3: Passive Problems
If you’re a passive recipient of your RSU’s and just let them vest without doing anything then this next truth could burn you. You may have taken a passive approach for several reasons. Maybe it’s because you think you’re getting an exclusive tax benefit for holding, maybe it’s because you’re lazy/busy/unmotivated, or maybe it’s because you’re drinking too much company Kool-Aid and you think it’s gonna takeoff. Regardless, as your RSUs vest, your net worth slowly becomes more concentrated and dependent upon a single stock.
So you’re probably thinking to yourself “oh I need to diversify.” which is correct, but the way you go about diversifying can really cause some serious problems.
For example, if you go out and immediately try and fix this by selling everything or even a large chunk, you’ll probably create another big problem—a huge tax bill. Are you starting to see how any financial move you make has correlated tax and other consequences? You’ll want to take a holistic approach to selling your RSUs. What are your values and goals? Risk tolerance and capacity? Then you’ll want to run multi-year tax projections to see when it makes most sense to sell. That may be selling immediately, or it may be selling over several years. BUT if you strategize and plan, then you create opportunities for yourself including the potential to RETIRE EARLY on your RSUs, which I show you how many RSUs you need in order to create $100k/year in retirement below.
