How Are RSUs Taxed? A Look at Vesting and Sales

Restricted Stock Units (RSUs) are a common form of equity compensation. This article clarifies the tax implications of RSUs, from the moment they are granted to when they are eventually sold.

Understanding Restricted Stock Units

Restricted Stock Units are a form of compensation where an employer promises to deliver shares of company stock or their cash equivalent to an employee at a future date. These units are “restricted” because they are subject to certain conditions, typically time-based, which must be met before the employee gains full ownership. The initial promise of shares is known as the “grant.”

Vesting occurs when employer conditions are satisfied, and the employee takes ownership of the shares. Vesting schedules can vary, with some plans releasing shares over several years in increments (graded vesting) or all at once after a specified period (cliff vesting).

Taxation at Vesting

At vesting, the fair market value (FMV) of the shares an employee receives is considered ordinary income. This income is calculated by multiplying the number of shares that vest by the FMV per share on the vesting date. For instance, if 100 shares vest when the company’s stock is trading at $50 per share, the employee recognizes $5,000 in ordinary income.

This income is treated similarly to regular wages or a cash bonus. It is subject to federal income tax, state income tax, Social Security tax, and Medicare tax.

Taxation at vesting establishes the “cost basis” for the shares. The FMV of the shares on the vesting date becomes the employee’s new cost basis for those shares. This cost basis determines any future capital gains or losses when the shares are sold. Employers report this income, which is included in the employee’s taxable wages.

Taxation Upon Sale

After RSUs vest, they become shares of company stock that the employee can sell or hold. When these vested shares are sold, any difference between the sale price and the established cost basis (the FMV at vesting) results in a capital gain or loss. This gain or loss is subject to capital gains tax rules, separate from the ordinary income tax already paid at vesting.

The tax rate applied to capital gains depends on how long the shares were held after the vesting date. If the shares are sold one year or less after vesting, any profit is classified as a short-term capital gain. Short-term capital gains are taxed at the individual’s ordinary income tax rate.

Conversely, if the shares are held for more than one year after vesting before being sold, any profit is considered a long-term capital gain. Long-term capital gains have lower tax rates compared to ordinary income tax rates. For example, if shares vested at $50 and were sold immediately for $50, there would be no capital gain or loss. However, if they were sold for $60 after being held for 18 months, the $10 per share profit would be a long-term capital gain.

Withholding and Reporting

Employers manage the initial tax obligations related to RSUs at vesting. They are required to withhold taxes, including federal income tax, state income tax, and FICA taxes (Social Security and Medicare), directly from the vested shares. A common method for this withholding is “sell to cover,” where a portion of the vested shares is automatically sold to generate funds to cover the tax liability. Alternatively, an employer might allow for cash withholding, where the employee provides funds to cover the taxes.

The ordinary income recognized from vested RSUs is reported on the employee’s Form W-2. The fair market value of the vested shares is included in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages) of the W-2. When vested shares are sold through a brokerage account, the sale proceeds and the established cost basis are reported on Form 1099-B.

Managing RSU Taxation

Managing RSU taxation involves strategic decisions after shares vest. When taxes are withheld at vesting, employees often choose between “sell to cover” and other methods. While “sell to cover” is convenient as it automatically handles the tax payment, it reduces the number of shares an employee retains. Some employers may offer cash payment of taxes, which allows the employee to keep all vested shares, but requires sufficient liquid funds.

Tracking the cost basis of vested shares is key for future tax calculations. The fair market value on the vesting date determines this basis, and maintaining records of this value for each vesting event helps in calculating capital gains or losses upon sale.

The timing of selling vested shares can impact the tax treatment. Selling shares immediately upon vesting simplifies tax tracking, as there is generally little to no capital gain or loss if the sale price is the same as the vesting price. Holding shares for more than one year after vesting allows any appreciation to be taxed at the lower long-term capital gains rates, which can result in a lower tax burden compared to short-term gains. In situations where an employee has other capital gains, tax-loss harvesting, which involves selling investments at a loss to offset capital gains, might be a strategy to consider.

An 83(b) election, often associated with stock options, is not applicable or beneficial for RSUs. An 83(b) election allows for accelerating income recognition to the grant date, but RSUs are typically not taxed until vesting because they usually do not involve a substantial risk of forfeiture on the grant date that would make such an election advantageous.