RSUs and the RSU Tax Trap: How to Make Smart Decisions with Company Stock

Equity compensation can be a powerful way to build wealth, but Restricted Stock Units (RSUs) come with important considerations. Understanding how RSUs are taxed, how holding or selling affects your portfolio, and strategies to manage risk can help you make informed choices and avoid what’s known as the RSU tax trap.

What Are RSUs?

RSUs, or Restricted Stock Units, are a type of equity compensation that companies give employees. Instead of receiving cash, employees receive shares of company stock that typically vest over time. Once vested, the shares are yours to hold or sell, but taxes are owed on their value regardless of whether you sell.

How RSUs Are Taxed

When RSUs vest, the value of the shares is taxed as ordinary income, similar to a paycheck. Key points to understand:

• Taxes are owed regardless of sale: You may see some shares withheld for taxes, but the amount may not cover your total tax liability.

• Withholding may be lower than your actual rate: Standard withholding is approximately 22%, but higher earners may have an effective tax rate of 32–37%.

• “Tax surprises” are common: If insufficient withholding occurs, you may owe additional taxes when filing. Setting aside cash or adjusting withholding can help avoid this.

• Your vested shares may feel smaller than expected: Some shares are automatically sold or withheld for taxes.

Capital Gains and the RSU Tax Trap

After RSUs vest, the shares are considered an investment, and selling them triggers capital gains taxes:

• Short-term gains: If sold less than 1 year after vesting, gains are taxed at ordinary income rates (10–37%).

• Long-term gains: If sold after 1 year, gains are taxed at more favorable long-term capital gains rates (0–20%).

The RSU Tax Trap

The RSU tax trap occurs when you hold onto shares after vesting to optimize for long-term capital gains. Since ordinary income tax has already been paid at vest, holding can lead to:

• A concentration of company stock in your portfolio

• A large potential tax bill when you eventually sell

• Indecision and delayed action, which exposes you to more risk if your company underperforms the broader market

The “Cash Test”

A simple way to evaluate RSUs is to ask:

If this were a cash bonus, would I use it to buy company stock?

If the answer is no, it may make sense to sell some or all of the shares and diversify.

Real Risks of Holding Company Stock

Holding RSUs comes with several risks:

• If stock value declines, taxes have already been paid on a higher amount.

• Single-company stock tends to underperform diversified portfolios over time.

• Selling RSUs while buying shares through an ESPP may trigger wash sale rules, complicating taxes.

RSU Guidelines: How to Manage Your Shares

Here are practical considerations depending on your situation:

1. If You Haven’t Sold Any RSUs Yet

• Plan for taxes by setting aside cash or adjusting withholding.

• Use the cash test to evaluate whether holding company stock aligns with your goals.

• Holding too much stock concentrates risk; a pre-determined plan helps maintain balance.

2. If You’re Selling Some RSUs but Keeping Others

• Use a portion of proceeds to diversify into a balanced portfolio.

• Sell shares to fund short-term goals, such as buying a house, paying for education, or building an emergency fund.

• Keep only the shares that fit your risk tolerance and long-term strategy.

3. If You’re Selling All RSUs and Spending Them

• Be mindful of short-term capital gains if selling less than a year after vest.

• Prioritize short-term financial needs while keeping some investments for long-term growth.

4. Optimal Situation

• Sell and diversify into a balanced portfolio to reduce risk.

• Keep a small, intentional position in company stock if desired for long-term growth.

• Coordinate RSU decisions with your broader financial plan to support long-term goals.

Case Example: With a Plan vs No Plan

No Plan: Alex receives RSUs and holds all shares without strategy. Over time, their stock grows, but so does the potential tax bill. When Alex eventually sells, they face a large tax burden and high concentration risk. A market downturn would significantly impact Alex’s financial goals.

With a Plan: Jordan receives RSUs and works with a strategy. They sell portions over time, cover taxes, diversify, and keep only what fits their long-term plan. Jordan avoids large tax shocks, reduces concentration risk, and can meet both short-term and long-term goals.

Bottom Line

RSUs can build wealth, but the real advantage comes from managing taxes and risk together. Avoid letting fear of taxes dictate decisions. Focus on diversification, compounding, and aligning your equity strategy with your long-term financial objectives.

Take Action

Ready to take actionable steps to make the most out of your RSUs and solidify your financial foundation?

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Disclaimer: This content is for educational purposes only and should not be construed as personalized investment advice. All strategies discussed are general and may not be suitable for all individuals. Past performance does not guarantee future results. Before making financial decisions, consult a qualified financial advisor to assess your situation, risk tolerance, and objectives. Dynamic Financial Planning does not provide tax or legal advice — consult appropriate professionals for guidance.