Equity compensation can be a powerful wealth-building tool, but it also comes with some of the most common and costly tax surprises we see each year. As December approaches, employees with RSUs, stock options, and ESPPs often find themselves blindsided by unexpected tax bills, underpayment penalties, or missed planning opportunities. If you’ve received equity this year or exercised options, sold company stock, or had a big vesting event, this is your chance to get ahead of the year-end crunch. Here are some things to watch for.
Trap #1: Surprise Income from RSU Vesting
Restricted Stock Units (RSUs) are taxed as ordinary income on the day they vest, even if you don’t sell the shares, and that income gets reported on your W-2. The challenge here is that most employers only withhold 22% federal tax by default, which may be far too low if you’re in a higher tax bracket. Combine that with State and Local income taxes, and many clients find themselves facing a big surprise at tax time.
Example – Melissa’s Surprise Bill:
Melissa had $300,000 of RSUs vest this year. Her employer withheld 22%, but her actual marginal federal rate was closer to 37%. That left a tax gap of $45,000, which she didn’t notice until April. Because she hadn’t made estimated payments, she owed penalties on top of the unexpected balance due.
To avoid unexpected tax bills from RSU vesting, review your total RSU income for the year and make a year-end estimated tax payment if necessary or consider increasing your payroll withholdings. This is a good time to coordinate with your CPA to avoid penalties and unnecessary interest.
Trap #2: Ignoring Alternative Minimum Tax on Incentive Stock Options Exercises
If you exercised Incentive Stock Options (ISOs) this year and held on to the shares, you might be sitting on a phantom tax liability without realizing it. The “spread” between your strike price and fair market value at exercise gets added to your alternative minimum tax (AMT) calculation. Even if you haven’t sold the stock or realized any actual cash, if the spread is large, you could face a five-figure tax bill this April.
Example – David’s Phantom Income:
David exercised 10,000 ISOs at $10 when the stock was trading at $60. He spent $100,000 to buy shares now worth $600,000. The $500,000 spread counted as AMT income. David hadn’t sold, so he had no cash to cover the extra $120,000 tax bill he faced at filing.
Partnering with a financial advisor can also help you strike the right balance between minimizing your immediate tax bill and maximizing long-term capital gains. If you’ve exercised ISOs this year, it’s a good idea to run a year-end AMT projection. This can help you spot any significant AMT liability before tax time. If you find that the potential AMT exposure is high, making a disqualifying sale before the year ends can help reduce that burden.
Trap #3: Disqualifying Employee Stock Purchase Plan Sales Without Planning
If you sold shares from an Employee Stock Purchase Plan (ESPP) this year without meeting the holding requirements of two years from offering and one year from the purchase date, the discount gets taxed as ordinary wage income, and that “income” will hit your W-2. What’s worse, many brokerages misreport ESPP cost basis, which means you could overpay capital gains tax if you don’t adjust it manually.
Example – Priya’s Costly ESPP Sale:
Priya bought $20,000 of ESPP shares at a 15% discount. She sold after 10 months to lock in gains, thinking she was being smart. But because it was a disqualifying sale, the $3,000 discount showed up as W-2 income, and her brokerage also reported an incorrect basis. If she hadn’t adjusted it, she would have paid tax twice on the same $3,000.
Managing your ESPP sales starts with reviewing all the transactions you completed during the year to determine whether each was a qualifying or disqualifying disposition. Once you receive your 1099-B statement in February, carefully check the reported details and be prepared to adjust the cost basis on your tax return if needed to ensure accurate reporting. Working with a professional during this process can be especially helpful to guide you in interpreting complex forms, confirming the correct tax treatment for each transaction, and helping to identify any necessary corrections before filing your return.
Trap #4: Overpaying or Underreporting Capital Gains
Managing equity compensation can involve navigating dozens of transactions throughout the year, each with unique cost bases, holding periods, and tax rules. By the time tax season arrives, the information on your 1099 forms may be incomplete or inconsistent. This is particularly common with RSUs sold using automatic tax withholding, ESPPs where the reported cost basis is incorrect, and ISO or NSO exercises that include both qualifying and disqualifying holding periods.
Example – Kevin’s Missing Data:
Kevin had a busy year: RSUs vesting quarterly, ESPP purchases, and some option exercises. His 1099-B only listed sale proceeds, without adjusting cost basis for RSU income already taxed through payroll. If he filed as-is, he would have reported $60,000 of “missing” gains and overpaid thousands in tax.
To stay organized and ahead of potential pitfalls, it’s important to track your equity events throughout the year, keeping detailed records of exercise prices, dates, and sale proceeds. Sharing this information with your CPA well before tax season can help ensure your filings are accurate and that you avoid any unpleasant surprises.
Final Thought: Tax Surprises Are Preventable
There’s no way to eliminate taxes on equity compensation, but there are ways to plan for them. The challenge isn’t simply in paying taxes themselves, but from paying them late, paying more than necessary, or missing an opportunity to save. At Wealthspire, we help clients:
- Model year-end tax exposure
- Make strategic sell/exercise decisions
- Coordinate equity activity with their broader financial plan
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