If you’ve received a grant of restricted stock units (RSUs), you know how great they can be but also know how painful taxes can be. Every time a piece of your grant vests, it probably leaves you wondering, “How can I avoid taxes on these RSUs?”
While your options are limited for avoiding taxes directly, this article will give you 10 tips to legally avoid paying taxes on RSUs.
If you’re still learning the ins and outs of RSUs, you’re welcome to read our articles RSU Basics and When Do I Owe Taxes on RSUs to get up to speed.
Tip #1 - Max Out Your 401(k) on a Pre-tax Basis
The first way to avoid taxes on RSUs is to put additional money into your 401(k). This seems like a boring tip, but it’s extremely practical.
The maximum contribution you can make for 2024 is $23,000 if you’re under age 50. If you’re over age 50, you can contribute an additional $6,000.
Every dollar that goes into your 401(k) on a pre-tax basis avoids taxation completely. While it may not directly reduce your taxes from RSUs that are vesting, it will lower your taxable income, which will help keep your tax bracket as low as possible.
If you live in a state like California where income taxes can go all the way up to 13%, maxing out your 401(k) is a no-brainer because it helps avoid taxes both at the Federal and State levels.
Tip #2 - Max Out Your Health Savings Account (HSA)
If you have a high-deductible health plan for your health insurance, you can set up an HSA to set aside pre-tax money that will grow tax-free as long as the funds are used for medical expenses. An added bonus is that after age 65, you’re allowed to draw from it penalty-free; you will just need to pay the taxes.
The max a family can contribute for 2024 is $8,300. While this strategy is similar to maxing out your 401(k), the pre-tax dollars avoiding taxes adds up quickly.
If you have a partner and together you’re contributing $8,300 into HSAs and both contributing $23,000 into 401(k)s, you’re reducing your taxable income by $54,300.
Removing $50k+ of income should go quite a ways in reducing the taxes you have to pay on your RSUs.
Tip #3 - Contribute to a Dependent Care FSA
This tip isn’t applicable to everyone, but if you have a child that receives some form of daycare, you can reduce your taxes on RSUs indirectly by contributing to a Dependent Care FSA.
Whether your child attends a large daycare, a smaller in-home daycare, has a nanny, or has a fancy trilingual au pair, some of the expenses you pay can likely be covered under a Dependent Care FSA (sometimes referred to as a DCFSA). Check out the following site for a full list of qualified dependent care expenses.
Dependent Care FSAs work similar to an HSA or standard FSA. The way it usually works is you contribute to an account through your employer, the money goes in without paying taxes, then after you’ve had dependent care expenses come up, you request a refund check from the company managing the Dependent Care FSA.
The max a family can contribute to a Dependent Care FSA for 2024 is $5,000, which is extremely low if you ask us, but that’s another $5,000 you can avoid tax on and further help you on your quest to avoid taxes on your RSUs.
Tip #4 - Avoid Underpayment Penalties
Unless you make over $1M in a given year, your employer is likely going to withhold taxes for you at a rate of 22%. The problem with this is that you might be in a higher tax bracket than 22%.
If you make $350k, you’ll likely be in the 35% tax bracket if you’re single or in the 32% tax bracket if you’re married.
If the company withholds for you at 22%, they are missing 10-13% of withholdings you should be making.
When you go to file taxes, the IRS will have an amount that they expected you’ve already withheld. If you’re significantly below that amount, they may charge you penalties. A very simple way to avoid paying tax fees is to ensure you’re withholding properly with a CPA or other advisor. If you’d like us to run a calculation as part of a broader engagement we’re happy to do so.
We created a simple RSU Tax Calculator that helps determine how much you’ll owe from your vesting RSUs and tells you if you’re at risk of being underwithheld.
Tips #5 through #8 - Make Charitable Donations
If you’re so inclined, it may make sense to make charitable donations to reduce the taxes you owe from your RSUs. Remember, the larger the RSU vest, the more taxes you will owe. So if your vesting RSUs are going to bump you into an uncommonly high tax bracket, it might make sense to think about the charitable gifts that you’d like to make over the next 3-5 years and donate a larger sum during this larger-than-usual tax year.
If you aren’t usually charitably inclined, keep reading because there are some special trusts you might want to consider depending on the size of the RSU vest you’re anticipating. The first thing you’ll need to determine is if donating to one of these trusts will actually provide you a tax benefit.
Tip #5 - Donate Outright
The first option is to donate your vested RSUs outright or sell the RSUs immediately and donate a portion of the proceeds. You’ll want to be sure that you donate to a qualified charity, but there are some truly great organizations that can always use the help.
The outright donation you make (assuming you itemize deductions), will help offset the income you received from your vested RSUs.
Tip #6 - Establish a Donor Advised Fund (DAF)
A DAF is a charitable investment account. It’s typically used when you have stock that has appreciated in value, but can be useful even without.
Here’s how this vehicle works: (1) You contribute an asset (typically stock) to the DAF. (2) The DAF then sells the asset tax-free and the proceeds are invested based on how you’d like the funds invested. (3) From there, you can request that payments be made to different charities over time and can even do so anonymously.
It’s a great vehicle because it gives you a tax break immediately, but you can then donate slowly over time. It’s common to let children or other family members be the successors of DAFs and they can then choose charities to donate to after you pass.
As we mentioned, this is typically used more for highly appreciated stock, but it’s still a good charitable vehicle if you have taxes from RSUs you’re trying to avoid. You can set DAFs up at Schwab or Fidelity relatively easily and they aren’t expensive to create.
Here’s a simple diagram to help you visualize how a DAF works:
Tip #7 - Establish a Charitable Remainder Trust (CRT)
There are a few different versions of a CRT, and they can be great options if you still want to receive additional benefits in addition to avoiding taxes on your RSUs.
Here’s how a CRT works: You put money into the CRT and receive a deduction for that contribution. The contribution you made will then be donated to charity after some period of time. During that set period of time, you’ll be eligible to receive income from the investment portfolio held within the CRT you created.
So you’ll (1) receive a deduction in the first year you contribute money to the CRT and (2) you’re eligible to receive income from the CRT based on how the trust is written.
It’s a great vehicle for those who want to avoid taxes on RSUs by being charitable, but still want to receive a benefit from the donation you made.
Tip #8 - Establish a Charitable Lead Trust (CLT)
Similar to a CRT, there are different versions of CLTs. In order to set up either one of these, you’ll need to talk with an estate attorney, but the taxes you save and the benefits you could receive may be worth the effort.
Here’s how most CLTs work: You fund the CLT with the proceeds from selling your RSUs that just vested. During the funding, you agree to have the CLT pay a charity for some length of time (for example, 10 years). Because you’re required to pay income out during the next 10 years, you are able to take a deduction in year one immediately. But here’s the best part: After the 10 years have passed, whatever remains in the CLT goes back to the donor!
This used to be our favorite trust to use to avoid taxes on RSUs because it’s used to be common to receive about the same amount of money you funded the CLT with at the beginning. As the CLT spits off payments, it’s invested so that the growth can often outpace the payments. Currently this method is less beneficial due to higher interest rates, but it could still make sense if you’ve received a large grant of RSUs.
If you’re interested in setting up a trust like this, you’ll need to talk with an estate attorney and an accountant, but it’s absolutely a strategy worth considering if you’re trying to avoid taxes on RSUs.
Tip #9 - Establish a CLT That Sends Payments Into a DAF
If you really want to get fancy about how you avoid taxes on your RSUs, you can establish both a CLT and a DAF.
You can fund the CLT, receive a deduction, then have the required payments from the CLT go into a DAF that you manage. At the end of the term for the CLT, you will still be able to receive whatever is left in the CLT.
This adds some added complexity, but it’s gives you some flexibility from the DAF and you still receive some funds back at the end of the term of the CLT.
The following diagram is a little hard to decipher, but it’s intent is to illustrate the strategy.
Tip #10 - Move to a State With No State Income Tax
This strategy is not fool-proof. It will require significant planning and help from an accountant (as it can result in an audit if not done properly). Still, the option of moving to a state with no state income tax may be worth exploring as a way to reduce some of the taxes you’ll owe on future RSUs that vest.
Assuming your employer will allow you to work from a different state, you may be able to avoid some state income taxes by moving to a state that doesn’t have a state income tax (Washington, Texas, and Nevada to name a few). But if you move after a vest happens, you’re out of luck.
If you move before the vest happens, the IRS or State tax authority will calculate a ratio to determine how much state income taxes you owe in each state based on how long you’ve been in the new state since the grant date.
Again, and we can’t stress this enough, you’ll want to consult with a CPA to determine if moving to another state for the tax benefits would be worth the effort. If you’ve recently received a grant worth a few million dollars and it’s not going to vest for another year, assuming your employer will let you move out of a state with high income taxes, that move could save you a few hundred thousand dollars.
Tip #11 - Ensure Your Tax Return Accounts for Sales Properly
The next tip to avoid taxes on your RSUs is to ensure that your tax return is properly accounting for your RSU sales. RSUs can be taxed twice if you’re not careful.
Essentially what happens is that if you have a year where you sold RSUs, there’s a good chance that the basis of your holdings is not properly tracking at the brokerage where you sold your shares.
If this happens, it causes you to pay capital gains on the entire value of shares being sold - instead of a gain or loss based on the value your RSUs had at vest.
We highly recommend reading the full article and discussing with a professional who can assist.
Final Thoughts on Avoiding Taxes on RSUs
We’ve helped many people avoid taxes on their RSUs and we hope this article has provided you with some useful strategies. The basic strategies (like maxing out your 401(k)s and HSAs) may not require the assistance of a CPA or estate attorney, but the more complex strategies (like the DAFs and CLTs) most certainly will.
If this article was a bit over your head, we recommend going back and reading some of the articles we linked back at the beginning.
We’re happy to provide referrals and/or answer any questions you may have about this article. Just shoot us an email at team@equityftw.com.
Thank you for reading.
