Sell to Cover RSU: Tax Strategies & Tips

By: AJ Ayers, CFP®

In this article, we'll discuss one of the most popular yet often misunderstood tax withholding methods for RSUs—the sell-to-cover strategy.

So, you've landed that dream job at a public company, and part of your shiny new compensation package includes Restricted Stock Units (RSUs). Congratulations! But before you start daydreaming about cashing in those shares for a new car or a dream vacation, there's a crucial aspect you need to understand—taxes. Yes, the dreaded 'T' word that can turn your financial dreams into a complicated puzzle.

Sell-to-Cover Strategy

When it comes to RSUs, one popular tax withholding method is the sell-to-cover strategy. This approach involves the employer selling just enough of your vested RSUs to cover the tax burden and distributing the remaining shares to you. Let's discuss this method and compare it to alternatives like "same-day sale" and "cash transfer" in terms of tax efficiency.

Here's a custom scenario to illustrate the sell-to-cover RSU strategy in action:

Employee: Emily, a Product Manager
Company: InnovateTech, a public tech company
RSU Vesting Schedule: 4 years
Tax Withholding Rate: 25%
Share Price at Vesting: $20
Number of RSUs: 200

Scenario
Emily has been with InnovateTech for 4 years, and her 200 RSUs have fully vested. The current share price is $20, making the total value of her vested RSUs $4,000.

Sell-to-Cover Method in Action

Tax Obligation: With a 25% tax withholding rate, Emily owes $1,000 in taxes.
Shares Sold: To cover this tax, InnovateTech sells 50 shares on her behalf (50 shares x $20/share = $1,000).
Remaining Shares: Emily is left with 150 shares (200 original shares - 50 shares sold for tax).

Future Implications

Capital Gains: If the share price increases to $30 in a year, Emily's remaining 150 shares would be worth $4,500. If she sells, she would have a capital gain of $1,500 ($4,500 - $3,000). Assuming a capital gains tax rate of 15%, she would owe $225 in taxes.
Capital Loss: If the share price drops to $10, her 150 shares would be worth $1,500. Selling them would result in a capital loss of $1,500 ($1,500 - $3,000), which she could use to offset other income for tax purposes.

By using the sell-to-cover method, Emily efficiently covers her immediate tax obligations while retaining a significant portion of her RSUs, allowing her to benefit from future stock price movements. When it comes to managing RSU-related taxes, it's essential for employees to know their options and carefully consider factors like potential capital gains and losses before making a decision.

Tax and Diversification Considerations for RSUs

Withholding tax rates for RSUs will vary depending on the employee's tax bracket. It's critical to understand that this withheld amount MIGHT NOT cover your entire tax liability. For example, if you’re in the 37% marginal tax bracket and your RSUs are only sold to cover 22% federally, you’d have to plan accrordingly. 

Based on your overall finances, you may need to make estimated tax payments or adjust your withholdings on your W-4 throughout the year to avoid underpayment penalties. State income taxes may apply, so it is essential to understand the rules in your state.

Incentive stock options (ISOs) and non-qualified stock options (NQOs) are two other popular types of stock options. While they have similarities with RSUs, tax treatments for these options differ, so it's important to know which type you're dealing with and understand the tax implications.

Keep in mind that tax rules are complex and can change. It's always a good idea to consult a tax professional or financial advisor with experience in equity compensation to ensure you understand the tax implications and strategically plan your RSU transactions.

Diversification is another important consideration, especially for those with a significant portion of their wealth tied to a single company’s performance.

By selling RSUs and investing the proceeds in other assets, you can better protect yourself from potential loss of principal due to fluctuations in your employer's stock.