Taxation of equity compensation can be complicated and lead to unforeseen tax consequences. Understanding how this benefit is taxed can help participants maximize their value and more efficiently pursue their financial goals.
The good news it that by understanding the potential under-withholding on equity compensation distributions, clients can plan in advance and help avoid being hit by an unexpected tax bill, including possible underpayment penalties.
In most cases the taxable events related to equity compensation, e.g., vesting performance of restricted shares and/or units, or the exercise of stock options, are withheld at 22%. For many participants this withholding rate is lower than their actual tax rate. If the participant's income puts them at a higher overall tax rate, they’ll need to account for the difference between their withholding on their equity compensation and the actual amount due.
Take a couple filing jointly with a household income of $300,000 in salary and bonuses plus $150,000 in vesting restricted stock.
The 2025 Married Filing Jointly effective tax is 19.2%, or $57,693 on $300,000, and the couple withholds that amount from their salary and bonuses. When they receive the $150,000 in restricted stock, the withholding rate is 22% on the distribution, or $33,000, so the couple has withheld a total of $90,693.
But the equity compensation distribution has increased the couple’s income and pushed them into a higher tax bracket. The total federal income tax on $450,000 in this hypothetical example would be $98,125, or $7,342 more than they have already withheld, and that difference would need to be made up at the end of the year or by paying additional taxes during the year.
To account for the potential underwithholding, equity compensation participants could withhold more throughout the tax year, increase tax deductions (such as by increasing charitable contributions), increase estimated quarterly payments, lower their taxable income by participating in a nonqualified deferred compensation plan, if eligible, for example, or set aside extra funds to pay the difference.
Note that in most situations, employers do not let participants increase their withholding on equity compensation, so prior planning to help avoid an unexpected tax bill is necessary. Also, for taxpayers with an income from their employer over $1,000,000, the standard withholding rate for equity compensation is increased to 37%
An understanding of the basics will go a long way in equity compensation decision making, but the details of each situation are also very important. To maximize the value of their equity compensation, participants should understand and plan for how and when grants are taxed. Understanding the taxation of these benefits, including standard withholding amounts, will help make this planning more effective, and finding a tax professional with experience in equity compensation to help you plan for and prepare your taxes is highly recommended. Fidelity’s financial professionals are here to help you get the most of your benefits and effectively pursue your goals.