Why RSU Withholding Is Often Not Enough for High-Income Californians

Restricted stock units can be a powerful wealth-building tool. For many California technology employees, RSUs make up a meaningful part of total compensation.

But there is one common misunderstanding: withholding is not the same thing as tax planning.

When RSUs vest, your employer usually withholds taxes automatically. That can make it feel like the tax has already been handled. In reality, default withholding may be far below your actual tax rate, especially if you are a high-income California taxpayer.

That gap can lead to a large tax bill, underpayment penalties, or both.

Key Takeaways

• RSUs are generally taxed as ordinary income when they vest.
• Employers often withhold federal income tax on supplemental wages at a flat 22% rate up to $1 million of supplemental wages, while amounts above $1 million are generally subject to 37% federal withholding.
• High-income Californians may owe more than the default withholding because of federal income tax, Additional Medicare Tax, Net Investment Income Tax, and California income tax.
• California does not provide a lower state tax rate for capital gains. Capital gains are taxed as ordinary income for California purposes.
• RSU planning should include withholding review, estimated tax planning, diversification, and tax-aware portfolio decisions.

How RSUs Are Taxed

RSUs are usually taxed when they vest.

At vesting, the value of the shares is treated as compensation income. That income generally appears on your W-2 and is subject to payroll withholding.

For example, assume you receive 1,000 RSUs that vest when the stock price is $100.

Even if you do not sell the shares immediately, you may still owe tax because the vesting itself is treated as compensation.

Your cost basis in the shares is generally the value included in income at vesting. If you later sell the shares for more or less than that value, you may have a capital gain or loss.

The Problem: Default Withholding May Be Too Low

RSU vesting is often treated as supplemental wage income. Under IRS rules, supplemental wages may be withheld at a flat 22% federal rate if supplemental wages are $1 million or less for the year. Supplemental wages above $1 million are generally subject to 37% withholding.

That 22% rate can create a problem for high-income employees. A California employee with salary, bonus, RSUs, investment income, and spouse income may be in a much higher marginal tax bracket than 22%.

The issue is not that the employer did anything wrong. The issue is that payroll withholding is based on payroll rules, not a complete household tax projection.

A Simple RSU Withholding Example

Assume a California employee has the following household income:

If the employer withholds only 22% federal income tax on the RSU vesting, that may not fully cover the household's actual federal and California tax exposure.

The employee may still owe additional tax because household income may be subject to:

• Higher federal marginal tax rates
• Additional Medicare Tax on wages above applicable thresholds
• Net Investment Income Tax on investment income, if applicable
• California income tax
• California estimated tax requirements

Why California Makes the Gap More Important

California is especially important because it taxes capital gains as ordinary income and does not have a separate lower state capital gains tax rate.

That means a California taxpayer with RSUs, stock sales, bonuses, and investment income may have a larger state tax bill than expected.

This matters even more when RSUs are combined with other taxable events, such as:

• Selling vested shares
• Selling concentrated company stock
• Exercising stock options
• Receiving a large bonus
• Realizing capital gains from a portfolio
• Receiving K-1 income
• Selling real estate
• Having a spouse with significant W-2 or business income

RSU Withholding vs. Estimated Tax Payments

Withholding and estimated tax payments are both ways to pay tax during the year, but they are not the same planning tool.

Withholding usually happens through payroll. Estimated tax payments are made directly to the IRS and state tax agency.

For high-income Californians, the estimated tax rules can be especially important. The California Franchise Tax Board says taxpayers with current-year California adjusted gross income of at least $1 million, or $500,000 if married/RDP filing separately, must pay estimated tax based on 90% of current-year tax.

This can surprise people who are used to relying on prior-year safe harbor rules.

Why RSU Planning Should Happen Before Vesting Dates

Many employees look at taxes after the RSUs have already vested. That is often too late to make the best decisions.

Before major vesting dates, review:

• Expected RSU income
• Salary and bonus withholding
• Spouse income
• Investment income
• Expected stock sales
• Prior-year tax liability
• Current-year projected tax liability
• Federal and California estimated tax needs
• Whether extra payroll withholding should be requested

The goal is not to overpay tax unnecessarily. The goal is to avoid a surprise tax bill and make better decisions with the shares.

Should You Sell RSUs When They Vest?

This is an investment decision, not just a tax decision.

If the answer is no, then automatically holding all vested RSUs may create unnecessary concentration risk.

Selling some or all RSUs at vesting can help:

• Reduce company stock concentration
• Create cash for taxes
• Fund a diversified portfolio
• Support home purchase goals
• Build emergency reserves
• Reduce future capital gain exposure

However, selling may also create tax considerations, especially if the stock price has changed after vesting.

Common RSU Tax Mistakes

Mistake 1: Assuming Withholding Equals the Final Tax Bill

Withholding is only a prepayment. Your actual tax liability is calculated when your return is prepared.

Mistake 2: Ignoring California Tax

Many employees focus on federal withholding and underestimate the California impact.

Mistake 3: Holding All Vested RSUs by Default

Holding may be appropriate in some cases, but it should be intentional.

Mistake 4: Selling Shares Without Tracking Basis

Your cost basis generally starts with the value included as W-2 income at vesting. Incorrect basis reporting can lead to double taxation or reporting errors.

Mistake 5: Waiting Until April

By April, the tax year is over. Many planning options are more effective before vesting dates, stock sales, and year-end.

A Year-End RSU Tax Checklist

Before year-end, review these questions:

• How much RSU income has vested this year?
• How much federal tax was withheld?
• How much California tax was withheld?
• Did you sell any shares after vesting?
• Do you have capital gains or losses?
• Is your household income approaching California's high-income estimated tax threshold?
• Should you adjust payroll withholding before the final paycheck?
• Should you make an estimated tax payment?
• Are you overconcentrated in employer stock?
• Does your investment strategy reflect your after-tax goals?

Official Sources for RSU Tax Planning

Because RSU tax planning depends on current tax rules, the most important claims in this article should be checked against official guidance.

• IRS Publication 15: supplemental wage withholding rules
• California FTB: capital gains and losses
• California FTB: estimated tax payments

Final Thought

RSUs can help build wealth, but they can also create tax complexity. The key is not simply asking, "Did my employer withhold taxes?"

The better question is:

For high-income Californians, that difference can be meaningful.