Estimated Taxes and Safe Harbors for People With Equity Income

RSU vesting, option exercises, and stock sales rarely have enough tax withheld. Understanding the safe harbor rules can turn an April surprise into a manageable plan.

Most employees never think about estimated taxes because payroll withholding takes care of the bill. Equity compensation breaks that assumption. A large RSU vest, an ISO exercise, a tender offer, or a diversifying stock sale can generate income that is under-withheld or not withheld at all. In the Bay Area, the gap between what was withheld and what is owed can run into six figures, with underpayment penalties on top.

Why withholding falls short

Employers generally withhold on RSU vests and NSO exercises at the federal supplemental wage rate. Under IRS Publication 15, that rate is 22% until an employee's supplemental wages exceed $1 million in a year, after which 37% applies. California's supplemental withholding on equity income is 10.23%. For a household in the 35% or 37% federal bracket and the 9.3% to 12.3% California brackets, those rates fall well below the actual marginal rate. Capital gains from selling shares have no withholding at all, and neither does an ISO exercise that triggers alternative minimum tax.

The federal safe harbor

The tax system expects payment as income is earned. According to IRS Topic 306, most taxpayers avoid the underpayment penalty if they owe less than $1,000 after withholding, or if they paid at least 90% of the current year's tax or 100% of the prior year's tax through withholding and estimated payments. The Form 1040-ES instructions add an important wrinkle for higher earners: if your prior-year adjusted gross income exceeded $150,000 ($75,000 if married filing separately), the prior-year threshold rises to 110%.

The prior-year safe harbor is what makes planning tractable. You cannot know in January what your stock will be worth at a December vest, but you do know last year's total tax. If your withholding and estimated payments for 2026 add up to at least 110% of your 2025 tax, the federal underpayment penalty generally does not apply no matter how large this year's equity income turns out to be. The remaining balance is still due in April, so this is a penalty shield, not a tax reduction, and it requires setting aside cash for the eventual bill.

California has its own rules

The state does not simply mirror the federal system. The Franchise Tax Board uses a front-loaded schedule: 30% of the annual estimate is due April 15, 40% June 15, nothing September 15, and 30% January 15. California applies the same 90% current-year and 100% or 110% prior-year tests, but taxpayers whose current-year California AGI reaches $1 million ($500,000 married filing separately) lose the prior-year option entirely and must pay based on 90% of the current year's tax. For someone with a large liquidity event, that means estimating the actual year's tax rather than relying on last year's figure.

Practical approaches

There are a few ways to close the gap. One is to increase wage withholding through a revised Form W-4, which has an advantage: withholding is treated as paid evenly through the year regardless of when it occurred, which can cure an earlier shortfall. Another is to make quarterly estimated payments using the schedule on the IRS estimated taxes page, with the four 2026 payments due April 15, June 15, September 15, and January 15, 2027. Some employers allow higher withholding elections on RSU vests. When a large event occurs mid-year, an estimated payment in the following quarter can limit the penalty, since it is computed period by period.

Consider a hypothetical engineer whose 2025 total federal tax was $90,000. To meet the 110% safe harbor for 2026, she needs $99,000 of federal withholding and estimated payments. If her regular salary withholding covers $70,000, she may consider estimated payments or extra withholding totaling $29,000 spread over the year. If her RSUs vest at a high price and her true 2026 tax is $180,000, she still owes the difference in April, but without a penalty.

Trade-offs and limitations

Overpaying is its own cost. Cash sent to the government early cannot earn interest or be used elsewhere, and a large refund means you lent money at no return. Underpayment penalties are calculated as interest, meaningful but not catastrophic. The right balance depends on cash flow, the predictability of your equity income, and your comfort with a large April payment. Filing status changes, moves between states, and AMT from ISO exercises all complicate the math.

This article is for educational purposes only and is not tax, legal, or investment advice. Estimated tax rules are detailed and penalties depend on individual facts, so consider working with a qualified tax professional.

Important Disclosures

Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.