Tax Tips for Cash Bonuses, RSUs, and Stock Options

Dan Pascone |

Companies typically offer various types of bonuses, such as cash bonuses, stock options, and Restricted Stock Units (RSUs), and each comes with unique considerations. 

These bonuses, typically awarded annually, quarterly, or even as performance-based incentives, are a welcome windfall, but the tax implications can be an unanticipated cold plunge. 

Let's break down the key points and tax planning strategies so you can maximize your windfall without falling into a tax trap.

Cash Bonuses

Cash bonuses are straightforward; they’re taxed as ordinary income, subject to federal, state, Social Security, and Medicare taxes.

While they provide immediate liquidity, cash bonuses could push you into a higher tax bracket, meaning some or all of your cash bonus is taxed at a higher percentage than your salaried income. 

For example, Jim, who earns $230,000 annually, receives a $50,000 cash bonus. Under the current tax brackets, the base salary is taxed at 32%, and any dollar above $243,725 is taxed at 35%; the bulk of his bonus is taxed at the higher 35%. 

Stock Options (NSOs & ISOs) and Restricted Stock Units (RSUs)

Nonqualified Stock Options (NSOs) are taxed at the time of exercise. When exercised, the difference (known as the "bargain element"​)  between the exercise price (grant price) and the fair market value of the stock at the time of exercise is treated as ordinary income. 

This income is reported on your W-2 form if you are an employee or on a 1099 form if you are a non-employee participant.

Incentive Stock Options (ISOs) are potentially more favorable; they can be taxed at the capital gains rate if you meet certain conditions, such as holding the stock for at least a year after exercise and two years after the grant date. 

If not, they revert to being taxed like NSOs.

Restricted Stock Units (RSUs) are a similar form of equity compensation. Still, unlike stock options, which give you the right to purchase stock in the future, RSUs are actual shares of company stock that you receive as compensation.

Think of RSUs as being handed the keys to a new car—no extra steps needed; it's yours. On the other hand, ISOs are like a coupon for a discounted car purchase; you still need to go to the dealership and buy it. 

RSUs are taxed as ordinary income when they vest. The taxable amount is based on the fair market value of the shares at the time of vesting. 

Once vested, the shares are yours to keep, and any subsequent gains or losses are treated as capital gains or losses when you sell the shares.

Heads up: if your RSUs vest during a high-income year, your tax liability could significantly increase while your cash balance to pay it doesn’t necessarily change. 

For example, suppose you receive $100,000 worth of RSUs (based on the fair market value of the shares), and you’re in the 35% marginal tax bracket. 

You decide to hold onto the RSUs. Still, you incur an additional $35,000 in tax liability, which you’d have to pay out of pocket. 

Further, if you sell your RSUs for $250,000 in ten years, you’d pay capital gains tax (at least it’s long-term!) on the $150,000 difference. 

Performance-Based Bonuses

Often tied to achieving specific targets, performance-based bonuses are taxed as ordinary income when received.

They can be paid in various forms, including cash, stock options, or additional RSUs. Still, the payment method usually depends on the company's compensation structure, your contract, and your role within the organization.

You'll pay taxes on these bonuses through the usual payroll tax withholding. The bonus amount is added to your regular paycheck, and your employer will withhold the appropriate federal, state, and local taxes. 

The Ins and Outs of Big Bonus Tax Planning

Planning for a big bonus is more than visiting your city’s premier Rolex dealer or scrolling through luxury VRBOs– it starts with making smart strategic decisions to keep more of your money so you can actually do those things without eating into your nest egg. 

Timing Your Bonus

Regarding higher tax bracket planning, the most minor nuances can make all the difference.

Bunching your income involves timing your income to fall into one tax year, which can be beneficial if you expect to be in a lower tax bracket. Concentrating deductions and income in the most tax-efficient way can help you minimize your taxable income over multiple years.

For example, if you expect a lower income year, you might accelerate your bonus or other income into that year to take advantage of the lower tax rate. 

Alternatively, you can defer income into a year when you expect your deductions to be higher, maximizing the benefit of those deductions.

For example, receiving your scheduled bonus on December 31st a day later, on January 1, could save you tens of thousands of dollars– a few hours could be the down payment on that condo, boat, or summer vacation. 

If possible, work with your employer to time your bonus payout strategically. Some companies also offer non-qualified deferred compensation plans, allowing you to postpone receiving a portion of your income—and the associated taxes—until later.

Even if you plan on making more next year, you’ll still have ample time to plan to reduce your taxable income. 

Max Out Retirement Accounts

For starters, max out your 401(k) and tax accounts to the maximum allowed; in 2024, the limit is $23,000, with an additional $7,500 catch-up contribution for those 50 and older.

Contributing to a 401(k) lowers your taxable income because the money you put into the account is pre-tax, which means the amount you contribute is deducted from your gross income, reducing the total income subject to federal (and often state) income tax. You’ll pay tax on the 401(k) in retirement. 

For example, if you earn $250,000 and contribute $23,000 to your 401(k), you are only taxed on $227,000. 

Tax Loss Harvesting

By selling investments that have lost value, you can realize those losses and use them to  offset capital gains from other investments, reducing the tax you owe on those gains. 

So, while a cash bonus is considered ordinary income, selling RSUs is considered a capital gain, which can be offset by tax loss harvesting. 

If your capital losses from your tax loss harvesting exceed your capital gains, you can use up to $3,000 of the remaining losses to offset ordinary income ($1,500 if married filing separately). 

Any additional losses can be carried forward to future tax years to offset future gains.​ 

Keep in mind that losses must first be used to offset gains of the same type (i.e., short-term losses offset short-term gains, and long-term losses offset long-term gains), and then excess losses can be applied to the other type. 

Note #1: The wash sale rule specifies that if you buy the same or a substantially identical investment within 30 days before or after selling the original investment at a loss, you won’t be able to get the tax benefit of the realized loss​. 

Note #2: While tax-loss harvesting can reduce your tax bill in the short term, it also lowers the cost basis of the repurchased investments, potentially resulting in higher taxable gains when those investments are sold in the future.

Tap Into the Triple Tax Advantage of HSAs

HSAs offer triple tax benefits– contributions are tax-deductible, grow tax-free, and withdrawals for qualified medical expenses are tax-free. 

Maximizing contributions to an HSA can reduce your taxable income while saving for future healthcare costs.

For 2024, the IRS has set the HSA contribution limit at $4,150 for individuals with self-only coverage and $8,300 for those with family coverage. 

Charitable Giving & Donor-Advised Funds

A Donor-Advised Fund (DAF) is a charitable giving vehicle that allows you to make a charitable contribution, receive an immediate tax deduction, and then recommend grants from the fund over time. 

When you contribute to a DAF, you get an immediate tax deduction for the full amount donated, which can significantly reduce your taxable income for that year; this is especially useful if your bonus pushes you into a higher tax bracket.

You can also directly donate stock (i.e., stock granted from RSUs). When you donate appreciated stock to a donor-advised fund (DAF), you can claim a tax deduction for the full fair market value of the stock, provided it has been held for more than one year. Deductions for these types of donations are generally limited to 30% of your adjusted gross income (AGI). 

Check out our guide on DAFs to learn more about how they work for cash and stock donations.

You can make a single donation to a DAF and then decide over time which charities will receive grants, giving you flexibility to plan your charitable giving without the rush of end-of-year deadlines.

The funds in a DAF can be invested, potentially growing tax-free over time. This means your initial donation could have a greater impact as the funds appreciate.

If your itemized deductions don’t typically exceed the standard deduction, consider "bunching" donations into one year. By making a larger contribution to a DAF in a high-income year (such as when you receive a large bonus), you can exceed the standard deduction and itemize in that year, then use the DAF to distribute grants to charities over several years.

For example, let's say you receive a $50,000 bonus. Here's how donating to a DAF could work:

First, you donate $20,000 of your bonus to a DAF and receive an immediate tax deduction of $20,000, reducing your taxable income.

Over the next few years, you can recommend grants from the DAF to your favorite charities, spreading the impact of your donation.

If the $20,000 in the DAF grows due to investment, you can grant even more money to charities than your original contribution. 

Say your aggressive DAF strategy grows your initial contribution to $100,000 over ten years, and you choose to begin distributing the following year. You, or the charities, incur no taxes on the growth. 

While DAFs reduce your taxable income, you’re still giving money away; there’s no “loop-hole” here where you end up with more money than you gave away.

Big Bonus Considerations

Large bonuses can trigger the Alternative Minimum Tax (AMT), which was designed to ensure high earners pay a minimum level of tax, even if they use deductions and credits to lower their regular tax liability. 

It’s essentially a separate tax system used if your income passes a certain threshold, which can happen fairly quickly with a large bonus. 

Check out our guide on the AMT here, which explains how it specifically applies in ISO and RSU situations.  

The Net Investment Income Tax (NIIT) applies an additional 3.8% tax on investment income for high earners and is triggered if your modified adjusted gross income (MAGI) is over $200,000 (single filers) or $250,000 (married filing jointly).

Though it applies to income from investments like dividends, interest, capital gains, rental income, and other passive income sources and not your bonus directly, your bonus could put your income above the thresholds, triggering the NIIT on your investment earnings resulting in higher overall taxes.

If you're in a high-tax state like California, consider the impact on your state taxes as well. Some folks even time a move to a lower-tax state around their bonus payout, though this requires careful planning and documentation.

Keep in mind that you need to genuinely establish residency in the new state. This means you can’t just book a hotel for the week of your bonus and say you lived in the no-state-tax state. Establishing residency involves moving physically and changing your driver's license, voter registration, and primary address. 

The longer you live in the new state before and after receiving your bonus, the stronger your case.

The Long View: Integrating Your Bonus into Your Financial Plan

Bonuses are a delightful surprise—until the tax bill arrives. 

Doing all of the above, and especially working with a financial planner with explicit experience in reducing the tax bills of top earners, can help you keep more of what you’ve earned.

Even if you do get to keep most of your bonus, viewing this windfall in the context of a broader financial strategy is critical. For example, once your tax bill is accounted for, you can begin distributing your bonus into an emergency fund (perhaps a high-yield savings account to ensure you have 3-6 months of living expenses saved), reducing high-interest debt, like credit cards, diversification, and other long-term goals like Roths if your 401(k) is maxed out. 

As compensation structures and their tax implications continue to evolve, staying informed and proactive in your approach to bonus planning is essential for turning those big paydays into lasting wealth