Do You Pay Taxes on RSUs? When and How They Are Taxed

Restricted Stock Units (RSUs) are a common component of employee compensation. These equity awards represent a promise from an employer to issue company shares once certain conditions are met. Understanding the tax implications of RSUs is a frequent concern. This article clarifies when RSUs become taxable and how they are assessed.

What Restricted Stock Units Are

Restricted Stock Units are a form of equity compensation used by companies to attract and retain employees. Unlike stock options, RSUs do not grant the right to purchase shares at a set price. Instead, they promise to deliver actual company shares in the future. The “restricted” aspect means these units are subject to a vesting schedule, typically requiring the employee to remain with the company or achieve performance goals.

Upon successful completion of vesting requirements, RSUs convert into actual company stock shares. Before vesting, an RSU is a phantom share, holding no voting rights or dividend entitlements. Once vested, the employee gains full ownership of the shares, which then hold market value.

When You Pay Taxes on RSUs

Taxation of Restricted Stock Units does not typically occur when they are initially granted. At the grant date, there is generally no taxable event because the employee has not yet received the shares, and the units are still subject to forfeiture. The critical moment for tax purposes arises when restrictions lapse and RSUs vest.

The primary taxable event for RSUs occurs on the vesting date. On this date, shares become fully owned by the employee, and their fair market value is recognized as taxable income. This is the first instance where the RSU value is considered earned income, similar to a salary or bonus. Even if an employee holds onto the shares after vesting, the vesting event triggers the initial tax liability.

A second tax event arises if the employee sells the vested shares later. If shares are held after vesting and then sold, any change in value between the vesting and sale dates can lead to additional tax implications. This means an employee faces two distinct tax considerations: one at vesting and another upon selling the shares.

How RSUs are Taxed

When Restricted Stock Units vest, their fair market value on the vesting date is fully taxable as ordinary income. This amount is added to an employee’s regular wages and is subject to federal income, Social Security, and Medicare taxes. Taxable income is calculated by multiplying the number of vested shares by the stock’s closing market price on the vesting date. This income is treated like other compensation, subject to the same progressive tax rates as salary.

For example, if 100 RSUs vest when the stock is trading at $50 per share, the employee recognizes $5,000 in ordinary income. This $5,000 is included in the employee’s gross income for the year and reported on their Form W-2, specifically in Box 1. Employers are required to withhold taxes from this ordinary income at vesting, often through a “sell-to-cover” method or by withholding cash.

If an employee holds and later sells vested shares, a capital gains or losses event occurs. The cost basis for these shares is their fair market value on the vesting date, which was already taxed as ordinary income. When shares are sold, the difference between the sale price and this cost basis determines any capital gain or loss.

For instance, if 100 shares vested at $50 per share (cost basis of $5,000) are sold for $60 per share, the capital gain is $1,000 ($6,000 sale price – $5,000 cost basis). The tax rate applied depends on how long the shares were held after vesting. If held for one year or less from vesting, any gain is short-term capital gain, taxed at ordinary income rates.

If shares were held for more than one year after vesting, any gain is classified as a long-term capital gain. Long-term capital gains generally benefit from lower tax rates compared to ordinary income, typically 0%, 15%, or 20% for most individuals. If shares are sold for less than their vesting date fair market value, a capital loss is incurred. This loss can offset other capital gains and, to a limited extent, ordinary income. These capital gains and losses are reported on Form 1099-B by the brokerage firm and on Schedule D of the employee’s Form 1040.

Managing RSU Tax Implications

Employers typically manage initial tax withholding when RSUs vest, similar to regular payroll. A common practice is “sell-to-cover,” where a portion of vested shares is automatically sold to cover required income, Social Security, and Medicare tax withholdings. The employee then receives the remaining net shares after these taxes are paid. Some employers allow employees to use cash from other sources to cover the tax liability, avoiding the sale of vested shares.

The ordinary income from RSU vesting is included in Box 1 of your Form W-2 for the year of vesting. This amount reflects the fair market value of the shares on the vesting date, subject to all applicable employment taxes. It is important to review your W-2 to ensure this income is accurately reported and matches your records.

When you sell vested RSU shares, your brokerage firm will issue a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions. This form reports the gross proceeds from the sale and, in most cases, the cost basis of the shares sold. It is crucial to verify that the cost basis reported on your Form 1099-B is correct. The accurate cost basis should be the fair market value of the shares on their respective vesting dates.

Maintaining meticulous records of your RSU grants, vesting dates, and the fair market value on each vesting date is essential for accurate tax reporting. This documentation helps correctly calculate capital gains or losses when shares are eventually sold, especially if acquired through multiple vesting events at different prices. Ensuring the correct cost basis is reported helps prevent overpaying taxes on capital gains.