RSU Tax Withholding: Why 22% Is Never Enough (and What to Do About It)

A senior engineer at a public tech company watched 2,000 RSUs vest worth $200,000. Her broker sold shares to "cover taxes," she saw the net deposit, and moved on. Eight months later, she owed the IRS $12,000 at tax time — a surprise bill that could have been avoided with 10 minutes of planning.

This is the RSU withholding gap, and it catches even experienced engineers off guard.

The Withholding Math

RSUs are classified as supplemental income by the IRS under IRC Section 3402(g). Your employer withholds at the flat supplemental rate:

• 22% on the first $1 million of supplemental income
• 37% on supplemental income above $1 million

Why 22%? The IRS chose this rate as a rough middle-ground across all income levels. It matches the 22% tax bracket ($47,150-$100,525 for single filers in 2026) — but most tech employees earning RSUs are in the 32% or 35% bracket, making 22% woefully insufficient.

Your actual marginal tax rate — the rate applied to your last dollar of income — is almost certainly higher than 22%.

If your total income is $250,000+, your federal marginal rate is 32-37%. Add state tax and Medicare, and your true RSU tax rate is 40-55%.

How Sell-to-Cover Works

When RSUs vest, most employers use "sell-to-cover":

1. All shares vest into your account
2. Broker immediately sells enough shares to cover withholding
3. Remaining shares stay in your account

Example 1: $100K RSU vest at $250K salary (California)

500 RSUs vest at $200/share ($100,000 value):

But your actual tax liability on this $100K at a $250K salary is closer to $47,000 — a $12,420 shortfall you'll owe when filing.

Example 2: $50K RSU vest at $150K salary

A more modest scenario, but the gap still bites. 250 RSUs vest at $200/share ($50,000 value):

Even at $50K in RSUs, there's a $4,535 shortfall — driven almost entirely by the federal under-withholding. Notice that California's supplemental rate (10.23%) actually exceeds the marginal rate (9.3%) at this income level, providing a small state-level buffer.

Complete Worked Example: $200K Salary + $100K RSU (California)

Here's the full tax walkthrough that shows exactly where the shortfall comes from:

Federal bracket walk-through (2026 rates, Single filer):

• Total W-2 income: $300,000
• Standard deduction: $15,000
• Taxable income: $285,000

RSU-attributable federal tax (incremental method):

• Tax on $300K total income: $68,059
• Tax on $200K salary alone: $33,814
• RSU-attributable federal tax: $34,245
• Federal withheld on RSU (22%): $22,000
• Federal shortfall: $12,245

State (CA) + Medicare:

• CA tax on RSU (incremental): ~$9,300
• CA withheld on RSU (10.23%): $10,230
• CA surplus: ~$930 (over-withheld)
• Medicare + Additional Medicare: $2,350 (withheld correctly)

Net shortfall: ~$12,245 - $930 = ~$11,315

The State Tax Surprise

State supplemental withholding rates often differ from actual marginal rates:

NIIT alert: If your adjusted gross income exceeds $200,000 (single) or $250,000 (married), you may also owe the 3.8% Net Investment Income Tax on investment income. While NIIT doesn't directly apply to RSU vesting (that's earned income), the extra W-2 income from RSUs can push your AGI above the NIIT threshold, making other investment income subject to the 3.8% surtax.

3 Ways to Close the Withholding Gap

1. Adjust Your W-4 Withholding

The simplest approach: increase withholding on your regular paychecks to cover the RSU shortfall.

How: On Form W-4, Step 4(c), enter the additional dollar amount you want withheld per paycheck. Divide your expected annual shortfall by the number of remaining pay periods.

Specific example: You estimate a $12,000 annual shortfall. You have 24 semi-monthly pay periods remaining.

• W-4 Line 4(c): Enter $500
• That's $500 extra withheld per paycheck × 24 = $12,000 in additional withholding

The advantage of W-4 over estimated payments: paycheck withholding is treated by the IRS as if it were paid evenly throughout the year — even if you increase it in October. This means no underpayment penalty for earlier quarters.

2. Make Quarterly Estimated Payments

If your vesting events are large or irregular, quarterly estimated tax payments (Form 1040-ES) give you more control:

State estimated payments are separate: CA uses Form 540-ES (pay via CA Web Pay), NY uses Form IT-2105 (pay via NY Online Services).

For a complete walkthrough of when and how to make estimated payments on RSU income, see our estimated tax guide for RSU income and the quarterly estimated tax guide for equity compensation.

3. Increase Your Sell-to-Cover Percentage

Some brokers (Schwab, E*Trade, Morgan Stanley) let you specify a higher sell-to-cover percentage. Instead of the default, set it to your actual marginal rate:

This eliminates the shortfall entirely — you just keep fewer shares.

Underpayment Penalty

If your shortfall exceeds $1,000 and you don't meet either IRS safe harbor (90% of current-year tax or 110% of prior-year tax), you'll owe an underpayment penalty. The penalty rate equals the federal short-term rate + 3 percentage points, adjusted quarterly (IRC Section 6654). In 2026, this rate is approximately 7-8%.

Example: $12,000 underpayment for the full year at 8% = ~$960 in penalties — on top of the $12,000 you already owe. The penalty is calculated per quarter, so paying late in Q4 doesn't fix the Q1-Q3 shortfall.

For a deeper dive on safe harbor rules and penalty calculations, see our estimated tax guide for RSU income.

If You Also Hold ISOs

Many tech employees hold both RSUs and ISOs. If that's you, RSU vesting events change your AMT-free exercise limit for ISOs — the extra W-2 income from RSUs shifts your tax brackets upward.

Planning RSU sales and ISO exercises together can save significantly more than optimizing each in isolation. For a complete understanding of how RSUs are taxed across both events (vesting and sale), see our guide on how RSUs are taxed. For the bracket math behind all these calculations, reference the 2026 federal tax brackets.

Frequently Asked Questions

Is RSU income subject to FICA? Yes. RSU vesting income is subject to Social Security tax (6.2% up to the $176,100 wage base in 2026), Medicare tax (1.45%), and Additional Medicare Tax (0.9% on income over $200,000). Your employer withholds these as part of sell-to-cover. If your salary alone exceeds the Social Security wage base, no additional Social Security tax applies to the RSU portion.

Can I change my sell-to-cover percentage? It depends on your broker and employer plan. Schwab, E*Trade, and Morgan Stanley typically allow you to set a custom withholding rate through their equity compensation portals. Contact your company's stock plan administrator to check. Changes usually must be made before the vesting date.

Do I need to make estimated tax payments on RSU income? If your withholding shortfall will cause you to owe more than $1,000 at tax time, and you don't meet either safe harbor rule, then yes. The simplest alternative is increasing your W-4 withholding, which avoids quarterly deadlines entirely.

How is RSU income reported on my W-2? RSU vesting income is included in Box 1 (Wages) of your W-2 — combined with your salary. Most employers also show the RSU amount separately in Box 14 for reference, but this is informational only. The taxes withheld appear in Boxes 2 (federal), 4 (Social Security), 5 (Medicare), and 17 (state).

What if I don't pay the shortfall? The shortfall doesn't go away — it becomes tax owed when you file your return. If you owe more than $1,000 beyond your withholding, the IRS charges an underpayment penalty (approximately 7-8% annually) calculated per quarter. You'll owe the tax plus penalty plus interest when you file.