Equity Compensation Tax Risks Every Tech Professional Should Understand

By Ryan Goldenhar

Many of our clients who work in tech and receive equity compensation assume their employers handle the entire tax component, since they withhold a percentage when your RSUs vest. But the gap between what your employer withholds and what you really owe can create surprise tax bills, in some cases, of tens of thousands of dollars, sometimes more.

The Withholding Gap

When your RSUs vest, your employer is required to withhold taxes. The IRS mandates a 22% withholding rate for supplemental income (which includes RSUs) up to $1 million. Above $1 million, the rate jumps to 37%.

If you’re a high earner, though, your actual marginal tax rate is almost certainly higher than 22%.
The federal top bracket is 37%. Add state taxes in California (up to 13.3%), New York (up to 10.9%), or New Jersey (up to 10.75%), and your combined marginal rate can exceed 50%.

That means your employer might withhold 22% on your vesting RSUs when your actual tax liability is closer to 45% or more. That difference has to come from somewhere, and it usually shows up as an unpleasant surprise when you file your return.

RSU Tax Basics

RSUs are taxed as ordinary income when they vest. The fair market value of the shares on the vesting date becomes taxable income, added to your W-2 just like salary.

This happens whether you sell the shares or hold them; vesting is the taxable event, not selling. Many people don’t realize this distinction.

If you hold the shares after vesting and they appreciate, you’ll pay capital gains tax on the additional growth when you eventually sell. Short-term gains (shares held less than a year after vesting) are taxed at ordinary income rates. Long-term gains (shares held more than a year) get preferential capital gains treatment. But the original vesting income is always ordinary income, taxed at your marginal rate.

ISOs vs. NSOs

Stock options can either be Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs). They’re taxed very differently.

• NSOs are more straightforward. When you exercise NSOs, the spread between your strike price and the current market value is taxed as ordinary income. Your employer withholds taxes, it shows up on your W-2, and you pay the bill.
• ISOs are more complex. When you exercise ISOs and hold the shares, you don’t owe regular income tax on the spread. If you hold the shares for at least one year after exercise and two years after grant, you qualify for long-term capital gains treatment on the entire gain when you sell.

The Alternative Minimum Tax Trap

The Alternative Minimum Tax (AMT) is a parallel tax system designed to ensure high-income taxpayers pay a minimum level of tax regardless of deductions.

When you exercise ISOs and hold the shares, the spread between your strike price and the fair market value counts as income for AMT purposes, even though it doesn’t count for regular income tax.
This creates what’s called “phantom income.” You haven’t sold anything, nor have you received any cash, but you owe real taxes on paper gains.

The tax rates for AMT are 26% on the first $232,600 of AMT income (for 2025) and 28% above that threshold. If your AMT calculation exceeds your regular tax calculation, you pay the AMT.

We work with clients to help determine where the AMT could be triggered based on their income level and ISO exercises in a given calendar year. AMT liability is a real cash cost against phantom value from exercising ISOs. There are ways to manage this each year, but it takes planning and constant check-ins during the year in coordination with any open trading windows that might need to be utilized to fix problems before December 31st.

Four Common Tax Risks

Often, equity comp tax hurdles come down to a few common but avoidable mistakes:

• Surprise tax bills from RSU underwithholding. Your employer withholds 22% when the actual rate should be 40%+, creating a gap that has to be paid at filing time.
• Triggering AMT without enough cash to pay. You exercise ISOs, the spread creates AMT liability, but the shares are illiquid or you don’t want to sell. Now you owe a tax bill you can’t easily pay.
• Not planning for state taxes. High-tax states like California, New York, and New Jersey add significant liability on top of federal taxes.
• Forgetting about estimated taxes. If your withholding doesn’t cover your liability, you’re supposed to make quarterly estimated payments. Missing these can result in underpayment penalties on top of the tax you owe.

Becoming Financially Unbreakable: The Power of Proactive Tax Planning

Consider these examples of proactive vs. reactive tax planning:

Proactive: Exercising ISOs gradually over several years to stay below AMT thresholds
Reactive: Exercising everything in one year and triggering a massive AMT bill

Proactive: Making estimated payments throughout the year to cover RSU withholding gaps
Reactive: Getting hit with a five-figure bill in April plus underpayment penalties

Tax planning doesn’t feel urgent until it’s too late. For tech professionals with significant equity compensation, though, it’s often the difference between building wealth and giving a chunk of it back to the government unnecessarily.

Keep visiting our site and follow us on LinkedIn to stay up to date with all our latest thoughts. Feel free to reach out directly if you have questions about your specific tax situation!

Frequently Asked Questions About Investment Risk

Why doesn’t my employer withhold enough on RSUs?
The IRS requires employers to withhold 22% on supplemental income up to $1 million, but if your marginal tax rate is higher (which it is for most high earners, especially in high-tax states), the 22% withholding falls short of your actual liability. The difference shows up as taxes owed when you file.

What’s the difference between RSU, ISO, and NSO taxation?
RSUs are taxed as ordinary income when they vest, regardless of whether you sell. NSOs are taxed as ordinary income when you exercise, on the spread between strike price and market value. ISOs have preferential tax treatment if you meet holding requirements, but can trigger Alternative Minimum Tax when exercised.

What is AMT and when does it apply?
The Alternative Minimum Tax is a parallel tax calculation that limits certain deductions and exemptions. For tech professionals, it most commonly applies when exercising ISOs. The spread between your strike price and fair market value counts as AMT income, potentially triggering tax liability even though you haven’t sold anything.

This content is provided for general informational and educational purposes only and does not constitute personalized investment advice or a recommendation of any particular investment or strategy. Tax information contained herein is not intended to be a substitute for specific tax advice. Individuals should consult with a qualified tax professional regarding their personal circumstances. MPS does not provide legal or tax advice. Investing involves risk, including the possible loss of principal. No investment or tax strategy can eliminate risk or guarantee outcomes.