RSU Tax Strategy – 4 (Unique) Ways to Lower Your Taxes in 2023
As a reminder, RSUs are taxed as income when they vest. There is no strategy to reduce or defer this tax directly.
However, as I’ll share below, with some proactive planning, you can use your RSUs to offset other income (thereby reducing your total tax bill) or delay capital gains taxes.
Let’s dive into the four (4) unique RSU tax strategies to consider in 2022.
1. Using RSUs to MAXIMIZE Tax-Deferred Contributions
Contributing to your employer-sponsored 401(k) account or an individual retirement account (IRA) comes with a tax benefit, as a contribution to these accounts reduces your taxable income in the current year. But an additional planning opportunity exists for anyone who is holding vested RSUs but not maxing out these accounts due to cash flow constraints.
If you are holding RSUs to delay paying taxes on the gains, the proceeds from the sale can be used to max out tax-deferred accounts and offset your tax bill (in addition to diversifying your investment portfolio).
The maximum employer 401(k) contribution for 2023 is $22,500 with an additional $7,500 catch-up contribution for those turning 50 or older in 2023. And the maximum IRA contribution is $6,500 with a $1,000 catch-up contribution available.
Let’s look at an example.
Marcia has 2,000 vested RSUs worth $10/share and a cost basis of $5/share. She has held the shares for more than two years and is contributing $11k of the allowable $20,500 in her employer's 401(k) plan. She is not contributing to an IRA account.
Additionally, her income places her in the 15% and 24% tax brackets for capital gains and income, respectively.
In this scenario, Marcia could sell her 2,000 shares for $20k, increasing the capital gains tax liability in the table below by $1,500 ($5 gain x 2,000 shares x 15% tax rate). Then she could use the first $9,500 of the proceeds to max out her 401(k) account—netting a tax reduction of $2,280 ($9,500 x 24%). With the remaining money, she could contribute up to $6k to a traditional IRA account and reduce her tax bill by up to another $1,440 ($6,000 x 24%)—subject to phaseouts based on income.
Here's what this looks like:
All in, this strategy could save Marcia up to $2,220 in taxes ($3,720 saved – $1,500 in capital gains tax) and add $6,720 to cash flow in the current year ($4,500 cash flow after retirement savings + $2,200 tax savings) while allowing her to diversify her investment portfolio and save money in a tax-advantaged account.
Now, for those of you already maxing out your retirement accounts, the next strategy might be for you.
2. Deduction Bunching
With the increase of the standard deduction to $25,900 for couples and $12,950 for individuals as part of the 2017 Tax Cuts and Jobs Act,deduction bunchingbecomes that much more important for anyone looking to itemize deductions as part of their tax returns.
Essentially, deduction bunching is squeezing as many deductions as possible into one tax year in order to boost itemized deductions above the standard amount and therefore minimize taxes in that year.
Because RSUs are taxed as income in the year they vest, if you have a large tranche of RSUs vesting in any given year, you should consider bunching deductions to offset some of this income.
The most common itemized deductions are:
- Mortgage Interest
- Charitable donations
- Medical expenses
- And State and Local taxes (known as SALT deductions) including real estate taxes
Because SALT deductions remain capped at $10k, and mortgage interest doesn’t lend itself to bunching, the opportunities here are mainly with charitable donations and possibly with medical expenses.
Medical expense deductions, starting in 2020, are limited to the “total qualified unreimbursed medical care expenses that exceed 10% of your adjusted gross income.” If you have a year with high medical expenses pushing you over the 10% threshold, the opportunity exists to prepay any upcoming costs and to pull as much of the deduction into the current year as possible.
For example, if your kid is due for braces, your orthodontist may allow for payments to be spread out over a couple of years. But, if you are over the 10% AGI threshold and can swing it from a cash flow perspective, you should consider paying the full cost upfront in order to bunch the expenses and pull the tax benefit into the current year.
Charitable giving is the same. If you are charitable and can afford to, in a high-income year driven by RSUs, you can pull five years of giving forward into the current year in order to bunch deductions and further reduce your tax bill. (In the next section, I’ll look at a popular vehicle to make this process easier.)
A side-by-side comparison of how this would look is below. In this scenario, we compare the standard deduction (without bunching) to itemized deductions with bunching. We assume an extra $2k in medical expenses (which are deductible) and bunching five years of charitable contributions at $5k per year + an extra $900 to make round numbers.
Standard Deduction | Itemized Deductions with Bunching | |
Mortgage Interest | $8,000 | $8,000 |
Charitable Deduction | $5,000 | $25,900 |
Medical Expense Deduction | $0 | $2,000 |
SALT | $10,000 | $10,000 |
Total Itemized or $25,900 if greater | $23,000 or $25,900 | $45,900 |
The bunching strategy results in an additional tax deduction of $20,000 in the current year with no reduction in subsequent years (since you will use the Standard Deduction) and saves you nearly $4,500 on your tax bill today.
3. Donor Advised Funds (DAF)
Let’s say you have the ability to pull five years of charitable giving forward, as in our example above. But, like many people, you would still prefer to give the funds over the five years while getting the tax deduction.
How can you achieve this? Enter thedonor-advised fund (DAF).
Here is a quick summary explaining how a DAF works:
- Open a Charitable fund in your name
- Contributions to the fund are deductible in the year received
- Assets can be invested and grow tax-free
- Grants can be made to charities at any time in the future
What’s more, highly appreciated securities can be used to fund a DAF—not only scoring a tax deduction in the funding year but also avoiding capital gains tax on the donated securities.
Essentially, utilizing a DAF allows the charitable bunching strategy combined with the capability to give as you typically would. The only downside is that you must have the ability to fund the account upfront, and the donation is irreversible. Once you’ve funded a DAF, the money must be given to charity.
4. Defer Taxes by Hedging With Options
While our first three strategies covered reducing your tax bill today, our last planning strategy explores a way to hedge your RSU position and delay the sale—either because you need to maintain a position in your company stock or to delay the tax bill to a potentially more favorable year.
A quick caveat—options can be risky and should be fully understood before implementing any strategy. Additionally, like with anything, there is no free lunch. Hedging a position, even if generating income in the process, comes with tradeoffs.
Let’s look at a couple of the most common strategies: The covered call and the collar.
Covered Call
Under this strategy, call options are sold above the current price (calledout of the money).This generates income but caps your potential for gain with essentially all the risk of loss remaining.
In the scenario below, using Intel’s stock from February of 2020, we depict this strategy of selling $70 calls that expire in January 2021. This brings in a premium of ~7% but caps your maximum gain on the position at 13%—at a price of $70 per share or higher. However, as you can see, the downside is essentially uncapped save for the 7% premium generated.
The tradeoff for generating this premium income is capping your return at 13% and still taking the downside of the stock. However, if the stock price doesn’t move over the next year, you have generated a nice healthy income stream over the period.
Collar
Unlike the covered call strategy, a collar strategy does hedge the downside by buying a put. However, instead of just buying a put (which is expensive), a call is also sold to offset some or all of the costs.
In our example below, selling January 2021 calls and buying puts on Intel stock leads to a premium income of 1.4%. The tradeoff is minimal income and a narrow range of potential outcomes.
Either of these strategies could be right for your given situation, but the point is they aren’t without risks and tradeoffs. However, they could help you defer the sale of your RSUs until a more favorable time.
RSUs vs. Stock Options
Unlike stock options, RSUs are almost always worth something even if the stock price of your company falls. For example, 1,000 RSUs at a company whose stock fell from $20/share to $10/share is still worth $10,000 versus potentially nothing with options.
However, with options, the advantage (or disadvantage) is the built-in leverage. Under RSUs, the difference between a stock price of $10 and $30 on 1,000 shares is $10k to $30k. However, this same range with 10,000 options (with a strike price of $18 as in the example above) results in a difference in value to the employee of $0-$120k.
Incorporating RSUs Into Your Investment Strategy
Think about it this way:
"If your company gave you a cash bonus, would you use that cash bonus to buy your company stock?"
If the answer is “no” you should probably sell your shares when they vest and reinvest the proceeds in a well-diversified portfolio.
Because of the increased risk of investing in individual companies, the vast majority of which will end up underperforming the market, it typically doesn’t make investment sense to hold onto the shares.
Researchby Longboard Asset Management revealed that from 1983-2006, nearly 2 in 5 stocks actuallylostmoney (39%), almost 1 in 5 lost at least 75% of their value (18.5%), and 2 in 3 underperformed the Russell 3000 index.
Now, it’s understandable to want to benefit from the potential success of your company, but this should be limited, as a rule of thumb,to around 10% and no more than 20%of your net worth.
Remember that not only do you have risk in the stock, but you also have career risk as well. If things go poorly at your company, not only does your stock and net worth get hit, but you might be out of a job and a paycheck at the same time.
However, if you did hold on to your RSUs and are fortunate to have capital gains (good for you!), taxes may now act as a barrier to diversifying. Is there anything to do?
Two ideas:
- If you have appreciated RSUs but aren’t maxing out your tax-deferred accounts (401(k), IRA, or HSA), your RSUs can be sold to fund these contributions and to diversify your portfolio. These pre-tax contributions can help reduce your tax bill that was just increased by realizing the capital gains.
- If you are charitably inclined, these shares can be allocated to aDonor Advised Fund, which can then be diversified and used to fund future charitable giving.
Trading Window and 10b5-1 Trading Plan
If you are a company executive or considered an insider with access to material, non-public information, take care to execute any liquidation or diversification strategy within your company’s and SEC guidelines. The two key guidelines are:
- A Trading Window: The period set by the company in which they allow executives and insiders to trade the company’s stock.
- A Rule 10b5-1 trading plan: A prearranged program for periodic purchases or sale of company stock that meet SEC criteria and avoid insider trading violations.