Are RSUs Taxed Twice? A Look at Vesting and Sales

Restricted Stock Units (RSUs) are a common form of equity compensation, frequently used by companies to attract, retain, and incentivize employees. These units represent a promise from an employer to deliver company stock or its cash equivalent once certain conditions are met, typically related to time spent with the company or performance milestones. While RSUs offer significant value, their tax treatment often leads to a common misconception: that they are “taxed twice.” This perception arises because RSUs are subject to tax at two distinct events, but it is not double taxation on the same dollar amount. Instead, different portions of the RSU’s value are taxed at different stages, reflecting their evolving nature from a promise to actual stock ownership and subsequent investment.

Taxation at Vesting

The first significant tax event for Restricted Stock Units occurs when they vest. Vesting is the point at which the restrictions on the RSUs are lifted, and the employee gains full ownership of the shares. On this vesting date, the fair market value (FMV) of the shares is treated as ordinary income to the employee.

This income is subject to all applicable federal, state (if any), Social Security (FICA), and Medicare taxes, similar to how regular wages or a cash bonus would be taxed. Employers typically handle the tax obligations at vesting through a withholding process. A common method is “sell-to-cover,” where a portion of the vested shares is automatically sold to cover the required tax withholding. Other methods might include “net shares,” where the employer issues fewer shares equal to the tax value, or requiring the employee to pay the tax liability in cash.

The default federal income tax withholding rate for supplemental wages, which includes RSU income, is generally 22% for amounts up to $1 million, and 37% for amounts exceeding $1 million. However, this flat withholding rate might not fully cover an individual’s actual tax liability if they are in a higher income tax bracket, potentially leading to additional taxes owed at year-end. The income recognized from vested RSUs, along with the taxes withheld, is reported by the employer on the employee’s Form W-2 for that tax year. Specifically, the value of the vested RSUs is included in Box 1 (Wages, Tips, Other Compensation) and often also detailed in Box 14 (Other Information) of the W-2.

Taxation at Sale

After RSUs vest, the shares become the employee’s property and are treated like any other shares of company stock. If the employee chooses to hold these shares beyond the vesting date and then sells them later, any change in value from the vesting date to the sale date will be subject to capital gains or losses. This subsequent taxation is not a “double tax” on the initial value already taxed at vesting. Instead, it applies only to the appreciation or depreciation that occurs after the shares vested.

The key to understanding this distinction lies in the concept of “cost basis.” For RSUs, the cost basis is established as the fair market value of the shares on the vesting date. This means that the portion of the value already taxed as ordinary income at vesting is not taxed again when the shares are sold. Only the difference between the sale price and this vesting-date cost basis is considered for capital gains or losses.

The tax rate applied to these capital gains depends on the holding period after vesting. If the shares are sold within one year of the vesting date, any gain is classified as a short-term capital gain and is taxed at the individual’s ordinary income tax rate. Conversely, if the shares are held for more than one year after vesting before being sold, any gain is considered a long-term capital gain, which typically qualifies for lower tax rates.

Understanding Withholding and Tax Reporting

When vested RSU shares are subsequently sold, the brokerage firm involved in the sale will issue a Form 1099-B, detailing the sale proceeds. Accurately reporting RSU sales on a tax return requires careful attention to the cost basis. Many brokerage forms, like Form 1099-B, may initially report a cost basis of zero or an incorrect amount for RSU sales.

To avoid overpaying taxes, taxpayers must adjust this reported cost basis to reflect the fair market value of the shares on their vesting date. This adjustment is typically made on Form 8949, and the resulting capital gains or losses are then summarized on Schedule D of Form 1040. Maintaining records of vesting dates and corresponding fair market values is essential for accurate tax preparation.