RSU 22% vs 37% Withholding: the $43K April Gap

The decision, with the numbers

Priya is a single software engineer at a large public tech company in Austin, Texas. Her base salary is $200,000, and in November $200,000 of restricted stock units vest, putting her total 2026 ordinary income at roughly $400,000. Texas has no state income tax, so this is a clean federal problem. Her question is the one every RSU recipient eventually asks: payroll withheld 22% on the vest — is that enough, or does she owe more in April?

It is not enough. At $400,000 of income, Priya’s top dollars sit in the 35% federal bracket (single filer, $250,526–$626,350 for 2026 per IRS Rev. Proc. 2025-32). The RSU income was withheld at 22%. The 13-percentage-point gap, layered on top of the way the vest pushes her ordinary income up the bracket ladder and triggers the 3.8% Net Investment Income Tax exposure, produces a federal shortfall of approximately $43,000 at filing. The decision is not whether to pay it — she will. The decision is when and how: write the check in April and eat an underpayment penalty, or adjust withholding / make an estimated payment before year-end and pay the same tax with zero penalty.

Why payroll withholds 22% — and why that is “correct”

RSU income is a supplemental wage. The IRS gives employers two ways to withhold on supplemental wages (IRS Pub. 15, Section 7). The most common is the flat-rate method: a single statutory rate applied to the supplemental amount.

• Supplemental wages up to $1,000,000 in the calendar year: the employer may withhold at the flat 22% statutory rate.
• Supplemental wages over $1,000,000 in the calendar year: the amount above $1M is withheld at a mandatory 37% — the top federal rate. This is not optional and cannot be lowered by a W-4.

Payroll is following the rule exactly. The 22% rate is “correct” in the sense that it is the legally permitted withholding rate. It is simply not calibrated to your bracket. For an engineer whose total income lands in the 24% bracket, 22% is close and the April surprise is small. For one in the 32%, 35%, or 37% bracket, 22% is wildly low — and the gap is yours to fund.

The $43K gap, line by line

Here is Priya’s $200,000 RSU vest, isolated. The shortfall stacks three defensible pieces: the bracket gap on the RSU dollars themselves, the 0.9% Additional Medicare Tax those wages trigger over the $200,000 threshold, and the 3.8% NIIT the higher income exposes on her taxable brokerage gains and dividends. Every line below uses Priya’s actual 35% marginal rate — no blended hand-waving.

The simplest way to see the core of the problem: if your marginal rate is 35% and only 22% was withheld, you are short 13 cents on every RSU dollar. On $200,000 that core bracket gap alone is $26,000. The figure climbs to roughly $43,000 once you add the 0.9% Additional Medicare Tax the vest triggers, the 3.8% NIIT on investment income now pushed over the $200,000 MAGI line, and the under-withholding on her regular salary — whose W-4 never anticipated $400,000 of total income. Had Priya lived in California (13.3% top rate), add roughly $26,000 more of state shortfall on top.

What most people miss: 22% is not a “tax rate,” it is a deposit

The most damaging myth is that the 22% withheld at vest is “the tax on the RSUs.” It is not. It is a deposit toward a bill that is settled on your Form 1040 at your real marginal rate. Two more misreadings follow from it:

• “My W-2 already shows the RSUs, so I’m covered.” The RSU value is added to Box 1 wages and the 22% to Box 2 withholding. The income shows up; the withholding does not match your bracket. The W-2 reporting being correct is exactly why the April bill is correct — and still unpaid.
• “I’ll just pay it in April, no harm done.” Paying in April is fine for the tax. It is not fine for the IRC Section 6654 underpayment penalty, which is charged as interest (federal short-term rate plus 3 points) on each quarter you were short. The IRS wants the money paid in evenly across the year, not in one April lump.
• “The 37% rate is the danger.” For most RSU recipients the 37% mandatory rate (on supplemental wages over $1M) actually over-withholds relative to a 35% bracket. The real trap is the 22% flat rate on a six-figure vest for someone in the 32%–37% range — that is where the shortfall lives.

The safe harbor: the number that makes the penalty disappear

You do not have to withhold your exact final tax to avoid the penalty. Under IRC Section 6654, you are penalty-free if your total payments (withholding plus estimates) reach the lesser of:

1. 90% of the current year’s total tax, or
2. 110% of last year’s total tax — the 110% figure applies when your prior-year AGI exceeded $150,000 (it is 100% below that threshold).

For a high earner, the 110%-of-last-year number is usually the easier target to hit and the one to anchor on, because it is a fixed dollar figure you already know from last year’s return. Take last year’s total tax (Form 1040, the “total tax” line), multiply by 1.10, and make sure your 2026 withholding plus any estimated payments reach that number. Hit it and the Section 6654 penalty is zero — even if you still owe a large balance in April.

Withholding has one structural advantage over estimated payments: it is treated as paid evenly across all four quarters regardless of when in the year it actually happened. An estimated payment counts only in the quarter you make it. That asymmetry drives the choice of lever below.

The two levers, and when to pull each

For Priya, with a November vest, there are too few paychecks left to absorb $43,000 through W-4 withholding alone. The clean move is a combination: bump Step 4(c) on the remaining paychecks and make a Q4 estimated payment by January 15 to reach 110% of last year’s tax. Because she crosses the safe harbor, the Section 6654 penalty is zero regardless of the April balance.

Sell-to-cover vs cash: the second decision the vest forces

Closing the withholding gap is the tax decision. The investment decision is whether to keep the shares at all. RSUs are taxed as ordinary income at the vest-date price — that price becomes your cost basis. Sell that day and your capital gain is essentially zero. Hold, and every further move is a taxable capital gain or loss on a concentrated single-stock position bought with after-tax dollars.

1. Sell-to-cover at vest liquidates just enough shares to fund the tax. It is the default for a reason: no concentration risk on the sold portion, near-zero gain, and the cash lands exactly when the tax is due.
2. Paying the tax in cash to hold all shares is a deliberate bet that this one company outperforms a diversified index, funded with your own savings. The honest test: at the vest-date price, would you buy these shares fresh with cash today? If not, you are holding out of inertia, not conviction.
3. Hold-and-wait-for-long-term-gains only helps if the stock holds or rises. The long-term capital gains rate (15% up to $533,400 of taxable income for a single filer in 2026, 20% above, plus 3.8% NIIT) applies after one year — but a one-year hold to save 5 points of tax is a poor trade if the stock can drop 30%.

If the vest pushes you over $1M of supplemental wages

Large grants and multiple vests in one year can push cumulative supplemental wages past $1,000,000. The moment you cross that line, the dollars above $1M are withheld at the mandatory 37% top rate (IRS Pub. 15) — no W-4 reduces it. For a 37%-bracket taxpayer, that is roughly the right rate and the April gap on those dollars closes itself. For a 35%-bracket taxpayer, the over-$1M portion slightly over-withholds, which means a small refund on that slice while the under-$1M portion (still at 22%) remains under-withheld. Run the two slices separately; do not assume crossing $1M fixes the whole bill.

The lever to pull this week

If RSUs are vesting this year and your total income lands in the 32% bracket or higher, treat the 22% withholding as a partial deposit, not the tax. Pull last year’s Form 1040, multiply the total-tax line by 1.10, and make your 2026 withholding plus estimated payments reach that number before the relevant quarterly deadline — January 15 for the fourth-quarter catch-up. That single action converts a penalized April surprise into a planned, penalty-free balance. Then decide, as a separate question entirely, whether you are keeping the shares: sell-to-cover unless you would buy this stock fresh today at the vest-date price.