Equity Compensation: 3 Mistakes That Can Cost You at Tax Time

Equity compensation can be one of the most powerful wealth-building tools available to you. It can also be one of the easiest to mishandle, especially when it comes to taxes.

Whether you receive RSUs, stock options, or ESPP shares, the timing of each decision matters. How you handle those events throughout the year determines how much of your equity you actually keep.

Below are three of the most common mistakes I see high-earning professionals make and how to avoid them before the year ends.

1. Not Planning for RSU Taxes When Shares Vest

When your Restricted Stock Units (RSUs) vest, the value of those shares is treated as ordinary income, even if you don’t sell right away.

Most employers withhold at a flat 22% federal rate, but many employees fall into the 32% or 37% tax bracket. That gap often leads to a surprise tax bill when you file.

How to fix it:

• Estimate your total income and calculate your true marginal tax rate.

• If your rate is higher than 22%, consider making an additional estimated tax payment or increasing your paycheck withholding.

• Track your cost basis carefully. Once your shares vest, any future gain or loss is taxed as a capital gain, not ordinary income.

Selling immediately upon vesting (“sell-to-cover”) can simplify things, but if you plan to hold, make sure you’ve accounted for the taxes.

2. Ignoring the AMT Risk on Incentive Stock Options (ISOs)

ISOs can create huge tax benefits, but they also bring the risk of the Alternative Minimum Tax (AMT).

When you exercise ISOs and hold the shares, the difference between your strike price and the fair market value becomes “AMT income.” Even though you haven’t sold, you might owe taxes on paper gains.

Example: You exercise 5,000 ISOs with a $10 strike when the stock trades at $40. The $30 difference per share creates $150,000 of AMT income, even if you never sell.

How to avoid it: Run a year-end AMT projection before exercising. Work with your planner and CPA to determine how many shares you can safely exercise without triggering AMT. If you’re in a high-growth company, spread your exercises across multiple years.

A little advance planning can prevent a major tax shock later.

3. Forgetting to Plan the Sale of ESPP Shares

Employee Stock Purchase Plans (ESPPs) can be a great deal, especially when there’s a 15% discount and a lookback provision. But if you don’t understand the tax rules, you can lose out on preferential treatment.

The key difference is between a qualifying and a disqualifying sale.

• A qualifying sale means you held the shares for at least two years from the grant date and one year from the purchase date. Most of the profit is then taxed at the long-term capital gains rate.

• A disqualifying sale happens when you sell sooner, which makes the discount taxable as ordinary income.

For most people, it’s still better to sell immediately after purchase. You lock in the guaranteed gain, diversify, and remove the risk of your company stock dropping in value.

Just remember to plan for the taxes on that discount income.

Coordinate Everything

Each equity type: RSUs, ISOs, and ESPPs has its own tax rules, but the real danger is failing to coordinate them.

If you receive RSUs, exercise options, and earn a year-end bonus in the same tax year, your income can spike higher than expected. That can push you into a higher bracket or reduce eligibility for certain deductions and tax credits.

Running a projection now, before the end of the year, lets you adjust payroll, estimated payments, and cash reserves. It’s one of the most valuable planning conversations you can have.

Final Thoughts

Equity compensation can change your financial life when it’s managed well. The key is being proactive instead of reactive.

If you’d like to review your equity compensation and see how it fits within your broader tax and investment plan, you can schedule your year-end review here: Book a Year-End Review with WealthBound Advisors

A few intentional steps now can help you keep more of what you’ve worked so hard to earn.

Disclaimer: This blog is for educational purposes only and does not constitute financial advice. Please consult with your attorney, advisor, tax professional, or mortgage lender before making a major purchase decision.