Are RSUs Taxed Twice? How RSU Taxes Actually Work

Restricted Stock Units (RSUs) are a common form of equity compensation offered by many employers. Their taxation often leads to questions and a common misconception about “double taxation.” This article aims to clarify how RSUs are taxed throughout their lifecycle and explain why the concern about being taxed twice is a misunderstanding of tax principles.

Taxation at Vesting

The initial tax event for Restricted Stock Units occurs when they vest. Vesting signifies the point at which the restrictions on the shares lapse, and they become fully owned by the employee. At this moment, the fair market value (FMV) of the vested RSU shares is recognized as ordinary income for the employee. This income is treated similarly to regular wages and is subject to various federal taxes.

The ordinary income recognized at vesting is subject to federal income tax, Social Security tax (FICA), and Medicare tax. Depending on the state and locality of residence, these amounts may also be subject to state and local income taxes. For instance, if 100 RSU shares vest when the company’s stock is trading at $50 per share, the employee recognizes $5,000 ($50 x 100 shares) as ordinary income. This amount is reported on the employee’s Form W-2 for the vesting year.

This taxation at vesting reflects the value received by the employee, much like a cash bonus that is then used to purchase company stock. The employer is obligated to report this income and withhold the appropriate taxes at the time of vesting. This initial taxation establishes the baseline value of the shares for future tax calculations, preventing that specific value from being taxed again.

Taxation at Sale

A second potential tax event occurs when the vested RSU shares are subsequently sold. Any gain or loss realized from this sale is subject to capital gains tax treatment. This means that if the shares are sold for more than their value at vesting, the increase in value is considered a capital gain. Conversely, if the shares are sold for less than their value at vesting, it results in a capital loss.

The crucial element in calculating this gain or loss is the “cost basis” of the RSU shares. The cost basis for RSUs is the fair market value of the shares on the date they vested. This is the amount that was already taxed as ordinary income. For example, if shares vested at $50 per share and are later sold for $60 per share, the capital gain is $10 per share ($60 sale price – $50 cost basis).

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

Withholding and Tax Forms

Employers typically handle tax withholding at the time RSUs vest. A common method is “sell-to-cover,” where a portion of the vested shares are automatically sold to cover the estimated tax liabilities. This ensures that the employee’s tax obligations for the ordinary income recognized at vesting are met. Some employers might also allow employees to pay the withholding tax with cash from other sources.

The ordinary income from vested RSUs is included in Box 1 (Wages, tips, other compensation) of the employee’s Form W-2 for the year of vesting. When vested shares are sold through a brokerage firm, the sale proceeds and the reported cost basis are detailed on Form 1099-B.

For tax reporting, the information from Form 1099-B is used to complete Form 8949, which details the sale of capital assets. The totals from Form 8949 are then transferred to Schedule D, Capital Gains and Losses, of Form 1040. It is important to verify that the cost basis reported on Form 1099-B accurately reflects the fair market value at vesting to avoid miscalculating capital gains or losses.

Why It’s Not Double Taxation

The perception of “double taxation” on RSUs often arises from the fact that taxes are paid at two different points: vesting and sale. However, these two tax events apply to distinct aspects of the RSU’s value, which means no single dollar of value is taxed more than once.

When RSUs vest, the fair market value of the shares at that moment is taxed as ordinary income, treated just like salary or a bonus. For example, if shares are worth $50 at vesting, that $50 per share is taxed as ordinary income.

When those same shares are later sold, only the appreciation in value after vesting is subject to capital gains tax. The value already taxed as ordinary income now becomes the cost basis for capital gains calculations. If the shares are sold for $60, the $10 increase is taxed as a capital gain, but the initial $50 is not taxed again. This adjustment to the cost basis prevents the same value from being taxed twice, as each tax event applies to a different component of the RSU’s overall value.