Do Restricted Stock Units (RSUs) Count as Income?

Restricted Stock Units (RSUs) are a common form of equity compensation provided by employers. While RSUs can be a significant part of an employee’s compensation, their tax treatment often leads to questions. Understanding how RSUs are defined and when they become taxable income is important for anyone receiving them.

Defining Restricted Stock Units

Restricted Stock Units (RSUs) are a promise from an employer to grant shares of company stock to an employee at a future date. Unlike direct stock grants, employees do not own the shares outright when RSUs are initially granted. Instead, delivery of shares is contingent upon meeting specific conditions, such as continued employment or performance goals.

The RSU lifecycle begins with a grant date, where the employer awards the units to the employee. These units then enter a vesting schedule, which dictates when restrictions lapse and shares are delivered. Vesting can occur over a set period (time-based vesting) or upon reaching specific performance milestones (performance-based vesting).

Once vesting conditions are met, the RSUs vest, and the employee receives the shares. Prior to vesting, RSUs have no voting rights and do not pay dividends directly. This structure serves as an incentive for employees to remain with the company, as the value of RSUs is tied to the company’s stock price.

The Income Event for RSUs

RSUs are considered taxable income at vesting, not when initially granted. This is because restrictions on the units lapse at vesting, and the employee gains full ownership of the shares. The fair market value of the shares on the vesting date is recognized as ordinary income.

The value from vested RSUs is treated as compensation, similar to regular wages or salary. This income recognition occurs regardless of whether the employee sells the shares immediately or holds onto them.

For example, if 100 RSUs vest when the company’s stock is trading at $50 per share, the employee recognizes $5,000 in ordinary income ($50 x 100 shares). This amount is added to the employee’s total taxable income. This initial income recognition is distinct from any capital gains or losses if shares are sold later.

Tax Implications at Vesting and Sale

When RSUs vest, the fair market value of the shares on the vesting date is subject to federal income tax, state income tax (where applicable), Social Security tax (FICA), and Medicare tax. Employers are responsible for withholding these taxes at vesting.

Employers commonly facilitate tax withholding by using a “sell to cover” method. Under this approach, a portion of the newly vested shares is automatically sold to cover tax liabilities. The remaining shares are then delivered to the employee’s brokerage account.

The fair market value of the shares at the time of vesting, which was already taxed as ordinary income, becomes the cost basis for those shares. This is a critical point for future tax calculations.

If the employee holds the shares after vesting and later sells them, any difference between the sale price and this established cost basis will result in a capital gain or loss. If the shares are sold within one year of vesting, any gain is considered a short-term capital gain and is taxed at ordinary income tax rates. If held for more than one year after vesting, any gain is a long-term capital gain, typically subject to lower capital gains tax rates.

Reporting RSU Income on Tax Forms

The ordinary income recognized from RSU vesting is reported on an employee’s Form W-2, “Wage and Tax Statement.” This amount is typically included in Box 1 (Wages, tips, other compensation), along with regular salary and other taxable compensation. The RSU income is also reflected in Box 3 (Social Security wages) and Box 5 (Medicare wages), indicating that it is subject to FICA and Medicare taxes.

If the vested RSU shares are subsequently sold, the sale transaction is reported on Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” which is issued by the brokerage firm handling the sale. This form provides details such as the gross proceeds from the sale, the date of sale, and often the cost basis of the shares, if the brokerage firm has this information.

The information from Form 1099-B is then used to complete Form 8949, “Sales and Other Dispositions of Capital Assets.” This form categorizes sales of capital assets and helps calculate gains or losses. The totals from Form 8949 are then transferred to Schedule D, “Capital Gains and Losses,” which summarizes all capital gains and losses for the tax year and is filed with the individual’s income tax return.