RSUs in Silicon Valley: Why Your Withholding May Not Cover Your Tax Bill
Restricted stock units are the backbone of tech compensation, but the way they are taxed in California surprises many employees every April.
Restricted stock units (RSUs) have become the default form of equity compensation at public technology companies across the Bay Area. They are simple to understand on the surface: shares are granted, they vest overtime, and once vested they are yours. The tax treatment, however, is where many Silicon Valley professionals run into trouble, particularly in a state with some of the highest marginal income tax rates in the country.
How RSUs are taxed at vesting
When RSUs vest, the fair market value of the shares on the vesting date is treated as ordinary wage income. It appears on your W-2 alongside salary and bonus, and it is subject to federal income tax, California income tax, Social Security (up to the annual wage base), Medicare, and California State Disability Insurance (SDI). There is no capital gains treatment at vesting; that only comes into play later, on any appreciation after the vesting date.
Because RSU income is classified as supplemental wages, employers typically withhold at flat statutory rates rather than at your actual marginal rate. Under IRS Publication 15, the federal supplemental withholding rate is 22% on the first $1 million of supplemental wages in a calendar year and 37% on amounts above that. California requires withholding on stock-based supplemental wages at 10.23%, according to a 2026 California RSU tax guide.
The withholding gap
Here is the problem. For tax year 2026, the federal 37% bracket begins at $640,600 of taxable income for single filers and $768,700 for married couples filing jointly, per the IRS inflation adjustments for 2026. Many engineers and managers with meaningful RSU grants land in the 32%, 35%, or 37% federal brackets, yet their employer withholds only 22% on vesting income. The difference between the withheld rate and the actual marginal rate accumulates with every vest.
The same dynamic applies at the state level. California's marginal rates climb through 9.3%, 10.3%, 11.3%, and 12.3%, with an additional 1% mental health services tax on income above $1 million, bringing the top rate to 13.3%, as summarized by NerdWallet's California tax guide. A 10.23% withholding rate can fall short for higher earners.
There is also a payroll tax that catches many people off guard. Since January 1, 2024, California SDI applies to all wages with no taxable wage limit; the California EDD sets the 2026 SDI rate at 1.3%. Every dollar of RSU income is subject to it.
Practical considerations
Employees who receive substantial RSU income may want to consider the following:
Review year-to-date withholding after each vest and compare it to a projection of full-year liability. A mid-year check is often easier than a scramble in December.
Understand your company's sell-to-cover mechanics. Many plans sell only enough shares to satisfy statutory withholding, not your full liability.
Evaluate whether quarterly estimated payments are appropriate. The IRS explains the rules and safe harbors on its estimated taxes page, and California has its own estimated payment requirements administered by the Franchise Tax Board.
Consider whether to increase regular payroll withholding via a revised Form W-4 rather than making separate estimated payments.
Holding versus selling after vesting
A separate question is what to do with vested shares. Because vesting income has already been taxed, holding the shares is economically equivalent to receiving cash and buying company stock with it. Whether that is appropriate depends on your total exposure to your employer, which already includes your salary, future grants, and possibly your ESPP. Shares held for more than one year after vesting may qualify for long-term capital gains rates on appreciation; the Kiplinger capital gains guide lists the 2026 thresholds. Note that California taxes capital gains as ordinary income and does not offer a preferential long-term rate.
The bottom line
RSUs are a valuable component of compensation, but the combination of flat withholding rates and California's progressive tax structure means that many Silicon Valley professionals owe more than was withheld. Building a simple withholding review into each vesting cycle can reduce surprises. Every situation is different, and you should consult a qualified tax professional regarding your specific circumstances.
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.
