Most people learn they had too little tax taken out in April, when a surprise bill arrives. With equity compensation, that surprise can be tens of thousands of dollars. The good news: the gap is predictable, and you can fix it during the year.
Why equity leaves you under-withheld
- RSUs and NSOs use a flat supplemental rate. Employers withhold 22% federal on supplemental wages up to $1 million in a year, and 37% above that. If your real top bracket is 32%, 35% or 37%, the difference is owed later.
- ISO exercises have no withholding at all. The spread can trigger AMT, and nothing is set aside for it.
- Stock sales have no withholding. Brokers don't hold back tax when you sell, so capital gains tax is entirely on you.
- State withholding is often flat too. California, for example, withholds 10.23% on bonuses and RSUs, which can fall short of the 12.3%+ top rate.
How to spot the gap
- Estimate your total tax for the year (our calculator does this).
- Add up what has been, and will be, withheld: pay stubs, RSU settlements, and any estimated payments.
- The difference is your gap. If it's over $1,000 federally, you may owe an underpayment penalty unless you meet a safe harbor.
Example: 4,000 RSUs settle at $25 ($100,000). Your employer withholds 22%, or $22,000. If that income lands in your 35% bracket, the real federal tax is $35,000, a $13,000 gap, before state tax.
How to close it
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Raise paycheck withholding with a new Form W-4. Withholding counts as paid evenly through the year, even if it's added in December, which can erase earlier underpayments.
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Ask for a higher RSU withholding rate if your plan allows it, or sell extra shares at settlement.
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Make an estimated payment through IRS Direct Pay or your state's site. Pay in the quarter the income happens to avoid penalties for that quarter.
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Set cash aside from any sale at your combined rate, not 22%.
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Add extra withholding on line 4(c) of your W-4. It counts as paid evenly through the year, so it can erase earlier-quarter penalties. See how to use W-4 Step 4(c).
What if you do nothing?
You'll owe the balance with your return, plus a possible underpayment penalty, calculated like interest on each quarter you were short. See penalties for paying late for how that's computed.
Run your numbers in the calculator to see your withholding gap by source.
Frequently asked questions
Is 22% withholding on RSUs enough?
Only if your top federal bracket is 22% or lower. Most people with meaningful equity income are in the 24% to 37% brackets, so 22% usually falls short.
Can I fix underwithholding late in the year?
Yes. Extra paycheck withholding is treated as paid evenly through the year, so increasing it in the fall can cover earlier quarters.
Official sources (for the detail-minded)
- IRS Pub. 15 (Circular E)Supplemental wage withholding rates (22% / 37%)
- IRS Pub. 505Tax withholding and estimated tax
- IRC §6654Underpayment of estimated tax by individuals
Run your own numbers
See your tax, take-home, and what to set aside. Free, and nothing is stored.
Keep reading
W-4 Step 4(c): How to Add Extra Withholding and Close a Tax Gap
Step 4(c) on your W-4 lets you add a fixed extra amount to every paycheck. It's the simplest way to close a gap from RSUs, commissions or a planned stock sale, and the IRS treats it more kindly than a late estimated payment.
Penalties for Paying Tax Late: Underpayment, Late-Payment and Late-Filing
Three different penalties can apply when tax is paid late. Here's what each costs and how the safe harbors keep you clear.
How commissions and bonuses are taxed and withheld
A commission check isn't taxed at a special rate, but it's withheld differently from your salary. Here's why big checks can look over-taxed, and why you may still owe in April.
How ESPP shares are taxed
Your ESPP discount is taxed when you sell, not when you buy. How much counts as salary depends on how long you held the shares.
Estimates only. Not tax, legal, or investment advice. See our methodology