Dealing with Unpaid Taxes from Restricted Stock Units (RSUs)

In an attempt to provide long-term incentives for employees, many employers have relied on stock-based compensation. Until recently, this primarily took the form of stock options. However, after the recent changes to accounting rules, some employers have instead provided restricted stock units, or RSUs, to their employees.

While usually simpler than other stock-sharing programs for employees to understand, RSUs still sometimes lead to confusion with respect the how they’re taxed. In some cases, this can lead to unexpected tax problems, like unpaid taxes and penalties. The goal of this article is to explain how RSUs work and what you can do to prevent a surprise tax bill. We’ll also discuss your options if the IRS has already assessed a tax balance that you can’t immediately pay.

An Overview of Restricted Stock Units 

RSUs represent a promise by an employer to give one or more shares of stock to employees at a later time. Unlike a stock option that gives the employee the option to purchase (or sell) shares of stock at a certain price, an RSU actually results in the employee receiving shares of stock (not just the option to buy them). In the majority of cases, the transfer of stock with an RSU depends on one or more conditions, such as continuing employment with the employer for a minimum amount of time and/or meeting certain performance milestones.

In addition to the conditions required for RSU vesting, employers may also establish the timeline for when employees receive shares of stock. Most employers set up their RSU compensation packages so that they vest over three to five years.

Only after this vesting period has lapsed and the employee met any other vesting conditions will the employer transfer the shares to the employee. In most situations, employees receive their stock shares immediately upon vesting. In other situations, the stock payout can occur sometime after the vesting date. 

Paying Taxes on Restricted Stock Units 

If you received compensation from your employer in the form of RSUs, you could have multiple taxable events to deal with. The first potential taxable event is when your RSUs vest. At a minimum, payroll taxes such as FICA must be paid at this time. If you also receive your stock shares at the time of vesting (which is most common), then you’ll also owe income tax on the value of the stocks you receive.

In the majority of situations, the value of the stocks you get from your RSU will be the number of shares received multiplied by the fair market value of the shares when you receive them. The IRS and most state taxing authorities consider this amount to be ordinary income, so the taxes you’ll pay on them are based on your ordinary income tax rate.

If your employer transfers shares of stock after the vesting date, then typically only the payroll taxes are due at vesting. Then when you receive your shares of stock, that’s when you’ll pay your income taxes on them.

Another potential taxable event could arise if you hold on to your shares after you receive them and they increase in value when you eventually sell them. If you decide to do this, you’ll have to pay a capital gains tax on the stock appreciation.

How much you owe in capital gains depends on how long you wait to sell the shares. If you sell your shares within 12 months of receiving them, then you’ll pay the short-term capital gains tax rate. This is the same tax rate you pay on your regular paycheck. If you sell them more than a year after you get them from your employers, then you’ll pay the long-term capital gains rate, which can be up to 20% of your gain in stock price, but the tax is typically only 15% and if your income is below a certain threshold, long-term capital gains are taxed at 0%.

Why You Might Have an Unexpected Tax Bill Because of RSUs

How RSUs get taxed is relatively straightforward (as far as taxes are concerned). But why does this often lead to an unpleasant surprise during tax season? It’s most likely the result of your employer not withholding the necessary taxes when your RSUs vest and/or when you receive your shares.

When your RSUs vest and your employer pays out your stock shares, there are three main ways for your employer to handle the tax withholdings. First, they can withhold all of your taxes for your regular paycheck, such as your portion of FICA and your income taxes. Second, they can withhold just some of the taxes you owe.

Third, they withhold none of the taxes you owe. As a result, you have to pay your portion of the payroll taxes (like FICA), plus the income taxes you owe. You owe these taxes at the time of vesting and the time you receive legal ownership of your shares. This means you’ll likely have to send an estimated quarterly tax payment to the IRS in the quarter(s) your RSUs vest and you receive the stock, and if you don’t, you will owe money when you file your tax return.

It’s the second and third scenarios that can result in an unexpected tax bill. This is especially true if your employer doesn’t tell you it’s not withholding all of the taxes you owe.

How to Avoid a Surprise RSU Tax Bill from the IRS 

You can prevent an unexpected tax balance stemming from your RSUs by talking with your employer. This discussion can include asking questions about the tax withholdings. For example, you can ask your employer how much of the RSU compensation they are withholding for taxes. If they’re not withholding enough, you can ask them to withhold a larger amount. If they decline to withhold enough, at least you now know that you’ll have taxes to pay when your RSUs vest and when you receive the shares.

Another thing to talk about with your employer is when you receive your shares of stock. Recall from earlier that most employers will distribute the shares at the same time the RSUs vest. But this isn’t always the case, especially if the employee requests otherwise.

In some cases, employers will be willing to delay when they transfer the shares of stock to their employees, even though the RSUs have already vested. For example, let’s say your RSUs vest on June 30 and your employer wants to pay out your shares on this date. However, you earn significant income and you plan on retiring at the end of the year.

Because your income next year will likely be lower than this year (as you’ll be retired next year), you might want your employer to wait until January 1 of the following year to disburse your shares. By doing so, you hope to pay less in income taxes as you’ll have a smaller income and therefore, you expect to be in a lower tax bracket.

There may also be other tax planning options available. The moment you learn about your RSUs, you should talk to your tax planning professional for advice on things you can do now, before your RSUs vest.

What You Can Do If You Have Unpaid Taxes on Restricted Stock Units 

If you find yourself in a situation where you’ve already received the unpleasant news of unpaid taxes, the first thing you should do is assess your situation. See if the IRS properly calculated your taxes and contact your compensation and benefits coordinator at work to see if there’s a mistake or misunderstanding somewhere. If your tax bill is large, review your financial situation to see how much cash you have immediately available to pay your taxes.

Assuming you’re sure that the tax bill from the IRS is correct, but you can’t pay it off in full right away, you can give the IRS a call to discuss your payment options. Depending on how much you owe and the basis for any penalties levied against you, you might be able to get an extension to pay off your tax debt and/or reduce or eliminate one of the penalties. Below are additional options to consider. 

Decide When and If to Sell Your Shares

Many employees will sell all of their shares the same day they receive them from their employer. However, this isn’t required, and you might have decided to hold on to the shares or only sell some of them. In this case, you can consider selling some or all of your remaining shares to cover your tax liability.

This decision will depend on various factors, such as other financial options for paying off the tax debt, whether the price of the stock has gone up or down since you received the shares, and in what direction you believe the stock price will go.

For instance, if you held on to your shares, but the stock price has fallen since you received them, then selling them will not only give you cash to pay off your taxes but the capital losses can be used to offset any taxable income you might have. Keep in mind there’s a limit to using capital losses to offset ordinary income, but you can offset all capital gains up to the value of your capital losses. Or if the stock price has gone up significantly, you might not want to sell as many shares, as some of the proceeds from the stock sale will be needed to pay the taxes you now owe on the gains you realized from selling.

Find Alternative Sources of Funding

You might have access to personal loans or lines of credit to help pay off your taxes. Maybe your home is paid off so a sizeable home equity line of credit is available. Or you have access to a credit card offer that charges you zero percent interest on cash advances. Other options include close family or friends you can borrow money from, selling property you already have, (like a car, boat, or personal property of significant value), and pulling money out of a savings or retirement account.

Be careful if pulling money from a savings or retirement account. Having access to an emergency fund could be worth paying interest to the IRS or there might be hefty financial penalties you have to pay for withdrawing from a retirement fund too early.

Pay Your RSU Tax Balance Over Time

If you’re like most taxpayers, this might be your most realistic option. You may have to pay interest or hire a tax professional to help you negotiate with the IRS or apply for a program. Yet these could be worthy costs if it means not having to sell your home or compromise your financial security. Some options to think about are:

• Payment Plan 
• Offer in Compromise (OIC)
• Currently Not Collectible (CNC) Status

Get Professional Tax Help

You can sometimes deal with your tax debt to the IRS on your own. You can do your own research to figure out your best solution, then contact the IRS directly to set things up. A short-term payment plan is a good example of this.

If you need more time to pay, owe a significant amount of money to the IRS, and/or have significant financial struggles, then other options can provide more time and even reduce how much you owe. However, applying for these (such as the OIC and CNC Status) can be difficult to do without the help of a tax professional, such as a CPA or tax attorney. 

Need Help Dealing with Taxes from Restricted Stock Units?

Whether you’re not sure how to deal with your RSU tax obligations or you just learned about a major tax bill, the tax pros at Damiens Law can help. We’ll start by helping you understand what’s going on and why. Then we’ll explain what your options are and which ones are most likely to help you the most. We offer free consultations, so you have nothing to lose by contacting us.