RSUs, ESPPs, and backdoor Roths: tax strategy for equity-compensated employees

Equity compensation can make up a large share of pay at tech and public companies. The tax rules are manageable, but the default settings tend to produce surprises.

RSUs are taxed as wages at vest

When restricted stock units vest, the fair market value of the shares is ordinary wage income on your W-2. Employers usually withhold federal tax at the flat 22% supplemental rate, or 37% on supplemental wages above $1 million. If your marginal rate is 32% or 35%, you're under-withheld by 10 to 13 cents per dollar.

You can close the gap in several ways:

• Ask payroll how to get extra tax withheld around vests, since the optional flat supplemental rate is fixed at 22%.
• Increase regular W-4 withholding.
• Make quarterly estimated payments, or rely on the safe harbor. If last year's AGI exceeded $150,000, or $75,000 if married filing separately, the safe harbor is 110% of last year's tax.

In Connecticut

• RSU and ESPP income is taxed in Connecticut just as on the federal return, but the state has no flat supplemental withholding rate. Employers compute Connecticut withholding on the vest plus that period's regular pay.
• Connecticut's estimated-tax safe harbor is the lesser of 90% of this year's tax or 100% of last year's, with no 110% rule for high earners. Payments are required when Connecticut tax after withholding is $1,000 or more, and the last 2026 installment is due January 15, 2027.
• If you commute to New York, part of each vest can be New York income. New York allocates stock compensation by your New York workdays, generally from grant to vest (Form IT-203-F), and counts normal workdays at home as New York days. Connecticut taxes the whole vest and credits the New York tax. See our Connecticut guide.

How to avoid paying tax twice on ESPP shares

With a qualified ESPP, part of the sale is taxed as ordinary income. That part is the lesser of the grant-date discount or your actual gain if you meet the holding periods, and the full spread at purchase if you don't. Brokers, however, often report cost basis without the discount on Form 1099-B, so using the broker's number means paying tax on the discount twice. Use the supplemental statement and Form 3922 to adjust basis.

Key numbers: 22% supplemental withholding · IRA contribution $7,500 · total 401(k) limit $72,000 · Roth catch-up rule above $150,000 FICA wages.

Backdoor Roth IRA

If your income exceeds the Roth IRA limits, the backdoor approach takes three steps:

1. Contribute $7,500, plus a $1,100 catch-up at 50+, to a nondeductible traditional IRA.
2. Convert it to a Roth IRA soon after.
3. Report the contribution and conversion on Form 8606.

The main complication is the pro-rata rule. If you have pre-tax money in any traditional, SEP, or SIMPLE IRA on December 31, part of the conversion is taxable. Rolling pre-tax IRA money into your 401(k) first can clear the way.

Mega-backdoor Roth

If your 401(k) allows after-tax contributions and either in-plan Roth conversions or in-service withdrawals, you can contribute beyond $24,500, up to the $72,000 total limit including employer money, and convert those contributions to Roth. For a high earner with a 4% match, that can mean $35,000+ of extra Roth savings a year.

A worked example

An engineer earning $260,000 has $120,000 of RSUs vest in 2026, withheld at 22%. At a 35% marginal rate, the RSUs alone leave her about $15,600 short. To close the gap, she raises W-4 withholding for the rest of the year. She also runs a backdoor Roth after rolling an old IRA into her 401(k), and adds $30,000 of after-tax 401(k) contributions converted to Roth.

Common mistakes

1. Selling RSUs at vest and assuming the sale is taxable a second time. Basis equals the vest value.
2. Using 1099-B basis for ESPP shares without adjustment.
3. Leaving a rollover IRA in place and triggering the pro-rata rule.
4. Holding too much employer stock out of reluctance to "pay the tax."

How Summer Associates helps

Summer Associates' individual planning team projects vest-year taxes, sets estimated payments, corrects ESPP basis on your return, and executes backdoor Roth steps with proper Form 8606 reporting.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.