Do You Pay Taxes on RSUs Twice? Here’s How It Works

Restricted Stock Units (RSUs) are a common form of equity compensation that companies use to attract and retain talent. While RSUs provide a valuable benefit, their taxation can seem complex, leading many to wonder if they are taxed multiple times. The U.S. tax system prevents “double taxation” on the same income, even though RSUs involve taxable events at different stages. This article will clarify how RSUs are taxed upon vesting and when sold, and how the tax system accounts for previous taxation to ensure fairness.

Understanding RSU Vesting and Initial Taxation

RSUs are not taxed when they are initially granted. Instead, the first taxable event for RSUs occurs when they “vest,” meaning the employee meets conditions to own the shares. At this point, the fair market value (FMV) of the vested shares is considered ordinary income, much like a cash bonus or regular wages.

This income is subject to federal income tax, state income tax (if applicable), Social Security, and Medicare taxes. Employers report this RSU income on the employee’s Form W-2 for the year in which the vesting occurs. To cover these tax obligations, employers often use a “sell-to-cover” method, automatically selling a portion of the vested shares. This withholding is often at a federal supplemental wage rate, though the actual tax liability may vary based on the individual’s tax bracket.

The value of the shares at vesting establishes the “cost basis” for those shares. This cost basis is a crucial figure because it represents the amount of income already recognized and taxed. For example, if 100 shares vest when the stock is valued at $50 per share, $5,000 is added to the employee’s ordinary income and becomes the cost basis for those 100 shares. This initial taxation ensures that the compensation received in the form of company stock is treated similarly to other forms of income.

Selling Vested RSUs and Subsequent Taxation

Once RSUs have vested, they convert into actual shares of company stock and the employee can choose to hold or sell them. If an employee decides to sell these vested shares, any gain or loss realized from the sale is treated as a capital gain or loss. This capital gain or loss is calculated as the difference between the sale price of the shares and their cost basis, which was established on the vesting date.

For instance, if shares vested at $50 and are later sold for $60, the $10 per share appreciation is a capital gain. Conversely, if sold for $45, the $5 per share decrease would be a capital loss. The taxation of this gain depends on the holding period after the vesting date. Shares held for one year or less from the vesting date result in short-term capital gains or losses, which are taxed at the individual’s ordinary income tax rates.

However, if the shares are held for more than one year from the vesting date before being sold, any gain or loss is classified as long-term capital gain or loss. Long-term capital gains generally receive preferential tax treatment, often taxed at lower rates such as 0%, 15%, or 20%, depending on the taxpayer’s income level. This distinction encourages longer-term investment and differentiates this taxation from initial ordinary income taxation at vesting.

Tax Reporting and Preventing Double Taxation

The U.S. tax system employs reporting mechanisms to prevent the same income from being taxed twice, even with RSUs. The ordinary income recognized at vesting is reported by the employer on the employee’s Form W-2, typically in Box 1. This ensures that the initial value of the RSUs is accounted for as earned income.

When vested RSU shares are sold, the brokerage firm involved in the transaction issues Form 1099-B, which reports the proceeds from the sale to both the taxpayer and the IRS. A common issue arises because brokerage firms often report a cost basis of $0 on Form 1099-B for RSUs, or mark them as “non-covered securities.” If this $0 cost basis is not adjusted, it can lead to the entire sale proceeds being mistakenly taxed again as capital gains, effectively creating double taxation.

To prevent this, taxpayers must adjust the cost basis reported on Form 1099-B when filing their tax returns. The correct cost basis for RSUs is their fair market value on the vesting date, which was already included as ordinary income on the W-2. This adjustment is made on Form 8949 and then summarized on Schedule D, Capital Gains and Losses. By accurately reporting the cost basis, only the appreciation in value (or depreciation) since the vesting date is subject to capital gains tax, ensuring that the portion already taxed as ordinary income is not taxed again.