How to Defer RSU Taxes: A Comprehensive Guide for High-Income Professionals

Restricted Stock Units (RSUs) have become an increasingly popular form of compensation, especially among professionals in tech and other industries. While they offer tremendous earning potential, the tax implications can be significant if not managed carefully. This guide dives into how to defer RSU taxes, helping you maximize your earnings while minimizing your taxable income. Let’s explore the strategies and benefits of deferring RSU taxes, along with actionable steps to implement these techniques.  

Understanding RSU Taxes

RSUs are taxed as ordinary income when they vest. The fair market value of the shares on the vesting date is included in your taxable income, subject to federal income tax purposes, Social Security, and Medicare taxes. Here’s a breakdown of how RSU taxes work:

• Grant Date: The time of grant when your employer promises you restricted shares (also referred to as stock grants).

• Vesting Date: The date when the shares are transferred to you and become taxable as ordinary income. For qualified employees, this is a critical point as the general rule dictates income is recognized at this stage.

• Post-Vesting: Any appreciation after the vesting date is taxed as capital gains when the shares are sold.

For example, if you receive 1,000 shares that vest at $50 per share, $50,000 is added to your taxable income in that calendar year. If the stock price appreciates to $70 by the time you sell, the additional $20,000 is subject to long-term capital gains tax if held for more than a year.

Strategies to Defer RSU Taxes

1. Deferral of RSUs Through Nonqualified Deferred Compensation Plans

Some employers offer nonqualified deferred compensation (NQDC) plans that allow you to defer the income from RSUs to a future date. Here’s how it works:

• Election Before Vesting: You must make a deferral election before the RSUs vest. This election allows you to defer the income until a specified date, such as retirement or another fixed date.

• Tax Benefits: Deferring the income delays federal income tax liability and may reduce state income tax if you relocate to a low-tax state before receiving the deferred income. For federal income tax purposes, this strategy can help spread your income over multiple years, reducing your overall tax burden.

Example: Assume you defer $100,000 worth of RSUs until retirement. By deferring, you not only postpone the tax liability but also allow the full value of the RSUs to grow over time without immediate tax consequences.

2. Utilizing Qualified Stock Options

RSUs can sometimes be coordinated with incentive stock options (ISOs) or other forms of qualified stock compensation. By leveraging ISOs, you can manage your taxable income more effectively and potentially benefit from long-term capital gains tax rates.

• Exercise Price and Voting Rights: Unlike RSUs, stock options come with an exercise price that must be paid to purchase the shares. Depending on the type of option, you may also gain voting rights upon exercising.

• Fringe Benefits: Employees may also receive fringe benefits as part of their equity compensation package, enhancing the overall value of RSU plans.

3. Selling Shares to Cover Taxes

When RSUs vest, many employers automatically sell a portion of your shares to cover tax withholding. While this doesn’t defer taxes, it prevents a surprise tax bill at the end of the year.

Tip: Work with a financial advisor to determine whether selling additional shares to prepay future taxes is beneficial. For private companies, special considerations may apply depending on liquidity events.

4. Donor-Advised Funds for Charitable Contributions

If you’re charitably inclined, consider using RSUs to fund a donor-advised fund (DAF). This strategy allows you to take a charitable deduction while deferring capital gains tax on appreciated shares.

Example: By donating $50,000 worth of RSUs to a DAF, you receive an immediate tax deduction and avoid paying taxes on the appreciation.

5. Bunching Deductions in High-Income Years

In years when significant RSUs vest, consider bunching deductions like mortgage interest, medical expenses, and charitable donations to maximize itemized deductions.

Key Benefits of Deferring RSU Taxes

• Increased Capital for Investment: Deferring RSU income allows the full value of the shares to grow without the immediate drag of income taxes.

• Tax-Efficient Retirement Planning: By aligning RSU income with a lower tax bracket in retirement, you can reduce your lifetime tax liability.

• Flexibility in Managing Tax Brackets: Deferral strategies can help you stay within a lower tax bracket during high-income years.

• State Income Tax Optimization: Relocating to a state with no income tax before receiving deferred RSUs can result in substantial savings.

• Enhanced RSU Plans: For qualified employees, working with employers to customize RSU plans can improve the alignment of equity compensation with financial goals.

How RSU Taxes Work: Key Considerations

1. Substantial Risk of Forfeiture: RSUs are subject to a substantial risk of forfeiture until the vesting date, which impacts their tax treatment.

2. Tax Withholding: Employers typically withhold taxes on RSUs at vesting, often at a flat supplemental wage rate.

3. Form W-2 Reporting: RSU income appears on your Form W-2 in the year of vesting.

4. Holding Period for Capital Gains: To qualify for long-term capital gains tax rates, you must hold the shares for at least one year after vesting.

Actionable Steps to Reduce RSU Tax Burden

Work with a Tax Advisor

A tax advisor can help you navigate complex IRS rules, such as Code Section 83(b) elections, and optimize your tax strategy.

Maximize Tax-Deferred Contributions

Use RSU income to fund your 401(k), IRA, or HSA, reducing your taxable income for the year.

Relocate to a Low-Tax State

If you’re planning to move, consider relocating before RSUs vest to take advantage of lower state income tax rates.

Diversify Your Investments

Don’t let RSUs become an oversized portion of your portfolio. Selling vested shares to diversify reduces concentration risk and aligns with your overall financial goals.

Common Questions About RSU Taxes

1. How do you defer RSU tax?
Utilize NQDC plans, relocate to a low-tax state, or elect deferral options if your employer offers them.

2. What is RSU tax withholding?
Employers typically withhold taxes on RSUs at vesting, often at a flat supplemental wage rate.

3. How does withholding shares to cover taxes work?
Employers may sell a portion of vested shares to cover your tax liability, reducing your cash outlay.

4. How do RSU taxes work?
RSUs are taxed as ordinary income at vesting, with capital gains tax applying to appreciation after the vesting date.

5. How do you reduce taxes on RSUs?
Strategies include deferring income, maximizing tax-deferred contributions, relocating to a low-tax state, and using charitable giving.

Why Work with a Financial Advisor

Navigating RSU taxation requires careful planning and expertise. At Arch Financial Planning, we specialize in helping high-income professionals like you optimize your financial strategies. From deferral planning to portfolio diversification, we provide personalized advice tailored to your goals.

Take Control of Your RSUs Today

Ready to reduce your RSU tax burden and take control of your financial future? Schedule an introductory call with Arch Financial Planning today. Let’s build a tax-efficient strategy that maximizes your earnings and aligns with your long-term goals.

This article is for informational purposes only and does not constitute financial or tax advice. Please consult a tax professional or financial advisor for advice specific to your individual situation.

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