6 Costly Tax Traps for Microsoft Employees to Avoid
Working at Microsoft comes with some serious financial perks, from stock awards to great retirement benefits. But with those perks come some sneaky tax traps that can catch you off guard if you’re not careful. Without a solid tax plan, you could end up owing more than expected.
Let’s break down the biggest tax pitfalls for Microsoft employees and how to steer clear of them.
1. The “Phantom Income” Tax Hit from RSUs
Restricted stock units (RSUs) are an important part of Microsoft's compensation packages. These can be a great way to grow your wealth. However, it’s worth noting that RSUs are taxed as soon as they vest — even if you don’t sell them.
When your RSUs vest, Microsoft automatically withholds 22% for these taxes. But if you’re a high earner, this is probably not enough to cover your full tax liability. That means that if you don’t set extra money aside, you could be in for a hefty tax bill when you file.
Example
Let’s say you have 5,000 RSUs that vest when Microsoft’s stock is $350 per share. Your taxable income instantly jumps by $1,750,000 (5,000 × $350). Microsoft withholds 22% in taxes ($385,000), but because you’re in the highest tax bracket (which is common at this income level), your actual tax bill is 37% ($647,500). That means you owe an extra $262,500 at tax time. If you didn’t plan ahead, you’ll have to scramble to come up with that money.
How to Avoid This Problem
Increase your tax withholding if the default 22% isn’t enough for your tax bracket.
Sell some RSUs right away to set aside extra cash for tax season.
Plan for the tax hit so you’re not caught off guard.
If you can afford to hold onto your shares, keep them for at least a year so that any future gains qualify for lower long-term capital gains tax rates.
2. The AMT Surprise for ISOs
Incentive stock options (ISOs) can also come with a hidden tax trap that many employees don’t know about. If you hold onto the stock after exercising your options, the IRS may hit you with the alternative minimum tax (AMT).
The AMT is a separate tax system that prevents high earners from using too many deductions to lower their tax bill. When you exercise your ISOs, the AMT system treats the “bargain element” (the difference between what you paid for the stock and what it’s worth at exercise) as taxable income. This applies even if you haven’t actually received any cash.
Example
Let’s say you have 10,000 ISOs with an exercise price of $50 per share. When Microsoft’s stock price reaches $100 per share, you decide to exercise your options and hold onto the stock, expecting it to rise even further.
At tax time, you’re hit with a surprise. Even though you haven’t sold any shares, the IRS considers the $50 difference per share (or $500,000 total) as taxable income under the AMT system. This unexpected tax bill forces you to sell some shares in a less-than-ideal market just to cover the tax liability.
How to Avoid This Problem
Exercise ISOs in small batches over a few years to keep your AMT bill lower.
Sell some shares immediately to get cash to cover your tax bill.
Work with a tax pro to estimate AMT before exercising options so you don’t get blindsided.
If you end up paying AMT, claim the AMT credit in future years to recoup some of that money.
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3. The NIIT and Medicare Tax
If your total taxable income — including salary, bonuses, RSU sales, and investment gains — goes over $200,000 (single) or $250,000 (married), you could get hit with two unexpected taxes:
A 3.8% net investment income tax (NIIT) on RSU sales, dividends, and capital gains
A 0.9% Medicare surtax on wages above those limits
Most Microsoft employees don’t realize that these taxes aren’t included in their standard paycheck withholdings. If you don’t plan ahead, you could be in for an unexpected tax bill at filing time.
Example
Let’s say your salary and bonus total $300,000, and in the same year, you sell $200,000 worth of RSUs. That pushes your taxable income up to $500,000, far beyond the threshold for these extra taxes.
Because of this, you owe an extra 3.8% tax on the $200,000 in RSU sales ($7,600 extra tax) and another 0.9% Medicare tax on $50,000 ($450 extra tax). This could take a big bite out of your profits.
How to Avoid This Problem
Spread out RSU sales over multiple years to keep your taxable income lower.
Max out your 401(k) and HSA contributions to reduce your taxable income.
Use tax-loss harvesting. Sell underperforming investments to offset some of the taxable gains from RSUs.
4. The ESPP Tax Trap
Microsoft’s employee stock purchase plan (ESPP) lets you buy company stock at a 10% discount, which can be an easy way to grow your wealth. However, selling those shares too soon can result in a bigger tax bill.
To qualify for the lower long-term capital gains tax rate, you must hold ESPP shares for at least two years from the offering date and one year from the purchase date. If you sell before meeting these requirements, your gains get taxed as ordinary income instead of capital gains, meaning you could pay up to 37% in taxes instead of 15-20%.
Example
Let’s say you participate in Microsoft’s ESPP and buy $20,000 worth of stock at a 10% discount, meaning you actually pay $18,000. Six months later, Microsoft’s stock price rises, and you sell for $25,000.
Since you didn’t hold onto the shares long enough, the IRS taxes the entire $7,000 gain at your ordinary income rate — which could be as high as 37%, instead of the 15-20% long-term capital gains rate you would’ve gotten if you had waited.
How to Avoid This Problem
Hold ESPP shares for at least two years from the offering date and one year from the purchase date to get lower tax rates.
Plan your sales strategically. Sometimes it makes sense to sell earlier, but know the tax impact before you do.
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5. Roth Conversions Gone Wrong
Roth conversions can be a smart tax strategy, allowing you to move money from a traditional pre-tax retirement account (like a 401(k) or IRA) into a Roth IRA. While this means paying taxes on the converted amount now, it allows your investments to grow tax-free, and you won’t owe taxes on withdrawals in retirement.
However, if you convert too much at once, you could unintentionally push yourself into a higher tax bracket, triggering additional taxes and even phasing out certain deductions or credits.
Example
Let’s say you decide to convert $500,000 from your traditional IRA to a Roth IRA in a single year. You’re expecting to save on taxes down the road, but in doing so, you bump yourself into the highest tax bracket (37%). That means you owe $185,000 in immediate taxes on the conversion — far more than you expected. On top of that, the increase in taxable income triggers additional Medicare surtaxes and could even phase out deductions you were counting on.
How to Avoid This Problem
Convert in smaller increments over multiple years to stay in a lower tax bracket and reduce your tax burden.
Time your conversions carefully—if you have a year with lower income (such as after retirement but before taking Social Security), that might be an ideal time to convert.
Consider using tax deductions and credits—charitable donations or business losses could help offset the tax impact of a conversion.
Work with a tax professional to model different conversion scenarios and determine the best approach for your situation.
6. The State Tax Surprise When Moving
Many Microsoft employees move from high-tax states like California or New York to tax-free states like Washington, Texas, or Florida, expecting to leave state income taxes behind. However, if you earned RSUs or other stock-based compensation while living in a high-tax state, you may still owe taxes on that income.
Some states, like California, tax stock compensation based on where it was earned, not where you live when it vests. That means even if you no longer live in a state with an income tax, you might still owe taxes on RSUs tied to the time you worked there.
Example
Let’s say you lived in California when Microsoft granted you 10,000 RSUs, but before they vested, you moved to Washington, which has no state income tax. You assume you won’t owe California taxes since you’re no longer a resident.
At tax time, you get an unwelcome surprise: California still considers those RSUs California-source income because you earned them while working in the state. That means you owe California’s 13.3% state tax on your RSU income, even though you don’t live there anymore.
How to Avoid This Problem
Time your move strategically. If a major RSU vesting event is coming up, consider whether delaying or accelerating your move could reduce your state tax burden.
Keep documentation proving when and where you earned your RSUs—pay stubs, employment contracts, and residency documents can help if there’s a tax dispute.
Consult a tax professional before moving. Some states are aggressive in claiming tax jurisdiction over stock compensation, and a professional can help you plan accordingly.
Let TrueWealth Help You Make the Most of Your Microsoft Benefits
At TrueWealth Financial Partners, we work with Microsoft employees every day to help them make the most of their stock compensation, retirement plans, and tax strategies. We know the ins and outs of your benefits and can help you create a tax-smart financial plan that works for you.
Don’t wait until tax season to figure it all out. Let’s build a strategy now so you can grow your wealth without unnecessary tax headaches. Schedule a free consultation today to get started!
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