How Does Restricted Stock Unit Tax Work?

It is common for employers to offer Restricted Stock Units, or RSUs, as a form of equity compensation to employees. Understanding the tax implications of these awards is important for financial planning and accurate tax reporting. This article explains how RSUs are taxed, from the initial grant to their eventual sale, providing clarity on the various stages of taxation.

What are Restricted Stock Units?

Restricted Stock Units (RSUs) represent a promise from an employer to grant shares of company stock to an employee at a future date. These units are a contractual right to receive shares once specific conditions are met, such as remaining employed for a certain period (time-based vesting) or achieving performance milestones. Vesting signifies when an employee gains ownership rights. Until vesting, the employee does not legally own the shares and faces a “substantial risk of forfeiture,” meaning unvested RSUs are typically forfeited if conditions aren’t met. Once vested, shares are delivered to the employee.

Taxation at Vesting

The primary tax event for Restricted Stock Units occurs when they vest. At this point, the fair market value of the shares on the vesting date is considered ordinary income. This value is treated like regular wages, bonuses, or commissions. Ordinary income is calculated by multiplying the number of vested shares by the fair market value per share on the vesting date.

This income is subject to federal income tax, Social Security, and Medicare taxes (FICA taxes). Employers are generally responsible for withholding these taxes from the vested RSU income. This income is reported on the employee’s Form W-2, typically in Box 1, “Wages, tips, other compensation,” for the tax year of vesting.

Taxation at vesting happens regardless of whether the employee sells the shares immediately or holds them. Even if shares are not sold, a tax liability is incurred based on their value at vesting. Employers often facilitate tax payments through withholding methods, such as selling a portion of the vested shares.

Understanding Your Tax Basis

Establishing the correct tax basis for vested Restricted Stock Units is important for accurate reporting of future sales. The cost basis for RSU shares is the ordinary income recognized at vesting, which is the fair market value of the shares on the vesting date. For example, if 100 RSU shares vest when the company’s stock is trading at $50 per share, the ordinary income recognized is $5,000 (100 shares x $50/share).

This $5,000 becomes the cost basis for those 100 shares. This basis represents the amount already taxed and should not be taxed again when sold, only any subsequent gain or loss. Keep records of vesting dates and fair market value on those dates. Proper tracking ensures that only the appreciation or depreciation in value after vesting is subject to capital gains tax. This ensures accurate tax reporting.

Taxation at Sale

When vested Restricted Stock Unit shares are sold, any gain or loss realized is treated as a capital gain or loss. This second tax event occurs separately from the ordinary income taxation at vesting. The capital gain or loss is calculated by subtracting the cost basis (established at vesting) from the net sale price. For instance, if shares with a cost basis of $50 per share are sold for $60 per share, there is a capital gain of $10 per share.

The tax treatment depends on the holding period after vesting. If shares are held for one year or less after vesting, any gain is a short-term capital gain, taxed at ordinary income rates (up to 37%). Selling shares soon after vesting may result in a higher tax rate on appreciation.

If held for more than one year, any gain is a long-term capital gain. Long-term capital gains benefit from preferential tax rates (0%, 15%, or 20%, depending on income). This distinction encourages holding investments longer to potentially reduce overall tax liability.

Tax Withholding and Reporting

Employers manage initial tax obligations for Restricted Stock Units through withholding mechanisms at vesting. A common method is “sell to cover,” where the employer sells a portion of vested shares to cover required income tax, Social Security, and Medicare withholdings. Remaining shares are then transferred to the employee’s brokerage account. This ensures the immediate tax liability at vesting is met without the employee providing cash.

Employees receive specific tax forms for reporting RSU-related income and sales. Ordinary income recognized at vesting (fair market value of vested shares) is reported on Form W-2, “Wage and Tax Statement,” typically in Box 1, “Wages, tips, other compensation.” Taxes withheld are shown in Boxes 2, 4, and 6.

If vested RSU shares are sold, the transaction is reported on Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions.” This form reports gross proceeds and often includes the cost basis. Employees must use both Form W-2 for ordinary income and Form 1099-B for capital gains or losses when filing their tax return.