How Are RSUs Journaled for US Federal Taxes and Cash Requirements?

Restricted Stock Units (RSUs) are a common form of employee compensation, particularly in publicly traded companies. Unlike stock options, RSUs follow a vesting schedule and convert into company shares upon vesting. Because they are considered taxable income at that point, understanding their financial impact is essential for tax planning and cash management.

Managing RSU-related taxes requires proper withholding, accurate journal entries, and ensuring sufficient liquidity to cover federal tax obligations.

Tax Withholding on RSUs

When RSUs vest, their fair market value (FMV) is treated as ordinary wage income and subject to federal income tax, Social Security, and Medicare taxes. Employers must withhold a portion of the vested shares or their cash equivalent to cover these liabilities.

The default federal withholding rate is 22% for amounts up to $1 million and 37% for any portion exceeding that threshold. However, if an employee’s actual tax bracket is higher, this may result in a tax shortfall when filing a return. Social Security tax applies up to the annual wage base limit ($168,600 for 2024), while Medicare tax applies to the full amount. An additional 0.9% Medicare surtax is levied on earnings above $200,000 for single filers or $250,000 for married joint filers.

Employers typically offer three methods for covering tax withholding:

– Share withholding: A portion of vested shares is automatically withheld.
– Sell-to-cover: Shares are sold on the open market to generate cash for taxes.
– Cash payment: Employees pay the tax liability out of pocket.

Each method affects ownership and liquidity differently, and employees should choose based on their financial situation and tax planning needs.

Journal Entries for RSU Equity

Recording RSU transactions in financial statements requires tracking timing and valuation. When RSUs are granted, no immediate journal entry is needed since they are not yet considered compensation expense or a liability. However, as employees earn the award over the vesting period, companies must recognize the associated expense.

Each reporting period, an expense is recorded based on the grant-date fair value of the RSUs, allocated over the vesting schedule. This is done by debiting stock-based compensation expense and crediting additional paid-in capital (APIC) in the equity section of the balance sheet.

For example, if an employee receives 1,000 RSUs valued at $50 per share with a four-year vesting period, the company records $12,500 ($50,000 ÷ 4) in compensation expense annually.

At vesting, the RSUs convert into actual shares. The company removes the full value of vested shares from APIC and reclassifies it into common stock at par value, with any excess remaining in APIC. If shares are withheld for taxes, a liability is recorded.

For instance, if 400 shares vest at $60 per share and 120 are withheld for taxes, only 280 shares are issued, and a payroll tax liability of $7,200 (120 × $60) is recorded.

Cash Requirements for Federal Taxes

Employees must plan for the tax impact of vested RSUs to avoid shortfalls. Since RSUs are taxed as ordinary income upon vesting, they can push employees into a higher tax bracket, increasing overall liability.

Estimating total tax exposure before vesting helps prevent surprises. This includes federal, state, and local taxes, as well as estimated tax payments for those with significant non-wage income. If withholding is insufficient, employees may need to make quarterly estimated payments to avoid IRS underpayment penalties, which are based on the shortfall and federal interest rates.

Liquidity planning is also important. RSUs that vest late in the year may not immediately require a cash outflow if withholding covers most of the liability, but any remaining balance will be due by the April 15 tax deadline. Employees planning to sell shares post-vesting to cover taxes should be mindful of market fluctuations, as a drop in stock price could leave them short on funds.